Investigating the effects of lower oil prices on aggregate U.S. output and household consumption

Abstract

In the last decade, there has been a gradual structural shift occurring in the U.S. economic landscape. Decreasing oil imports coupled with a booming oil sector and increased crude oil exports, implies that the oil sector now represents an increasingly larger part of total U.S. GDP. In light of the fracking revolution and the recent oil price decline of 2014, this thesis utilizes a SVAR model to study the effects of lower oil prices on U.S. real GDP and PCE. In so doing, we aim to investigate whether the transmission of an oil shock to U.S. economic activity has changed. Our analysis of the historical decomposition with data ranging from 1975-2016 suggests that the transmission of an oil shock remains unchanged. This is in line with findings made by Baumeister and Kilian (2016). Despite these findings, the effects of an oil price decline on U.S. real GDP and PCE are different when considering the recent changes in the U.S. economic landscape. Our findings suggest that an oil price decline has a significantly negative effect on both GDP and PCE post 2000. This is attributed to a number of changes; The increased importance of the oil sector as a contributor to U.S. GDP implies that reduced investments in the oil sector, as a consequence of lower oil prices, adversely affect GDP growth. Further, following the financial crisis, the FED rate was reduced close to the zero lower bound, effectively constraining the power of the FED to influence economic activity. Finally, a general cooldown of global economic activity implies reduced demand for American goods.