Oil Prices and the Global Economy: It's Complicated
IMF Blog, March 24, 2016
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Bibliographic details
- Authors: Maurice Obstfeld, Gian Maria Milesi-Ferretti, Rabah Arezki
- Published: March 24, 2016
Executive summary and headline findings
- Oil prices have been persistently low for well over a year and a half as of March 24, 2016; since June 2014 oil prices have dropped about 65 percent in U.S. dollar terms (about $70).
- Even accounting for the 20 percent dollar appreciation during this period (in nominal effective terms), the decline in oil prices in local currency has been on average over $60.
- Contrary to expectations that lower oil prices would be a net plus for the world economy, the widely anticipated “shot in the arm” has yet to materialize; global benefits from low prices will likely appear only after prices have recovered somewhat and advanced economies make more progress surmounting the low interest rate environment.
- World equity markets have tended to fall when oil prices fall; since August 2015 the simple correlation between equity and oil prices has been positive and has doubled compared with an earlier period starting in August 2014.
Supply versus demand drivers
- A fall in the world oil price can result from either an increase in global supply or a decrease in global demand; if driven by falling demand, we would expect falling prices accompanied by slowing global growth—with lower oil prices cushioning but likely not reversing the slowdown.
- Evidence suggests increased supply is at least as important as slowing demand:
- Oil supply has been strong owing to record high output from OPEC members (including exports from Iran) and some non-OPEC countries.
- U.S. shale oil supply initially proved surprisingly resilient despite lower prices.
- OPEC output has recently continued to grow as prices have fallen, unlike in some previous cycles.
- Econometric and other studies suggest only part of the recent decline in oil is due to slowing demand—somewhere between a half and a third—with the balance accounted for by increasing supply.
Domestic demand in oil exporters
- In 2015, domestic demand in oil exporters was much weaker than forecast in April 2015; the lion’s share of the downward revision for global demand comes from oil exporters despite their relatively small share of global GDP (about 12 percent).
- Weaker domestic demand reflected both weaker consumption and especially weaker investment:
- Rich oil exporters have drawn on reserves or sovereign wealth funds but have been cutting government spending sharply.
- Poorer oil exporters face limited borrowing capacity, rising sovereign spreads, sharply lower current account surpluses or higher deficits, and risk of crises.
- Large exchange rate depreciations in some countries have made imported goods more expensive, contributing to nonlinear falls in domestic spending.
- Public investment has fallen especially fast because most capital goods are imported and capital spending is often the first item cut during fiscal adjustment.
- Other negative factors in some exporters include domestic strife (Iraq, Libya, Yemen) and sanctions (Russia).
- Low oil prices have reduced profitability of exploration and extraction, lowering private capital expenditures:
- According to Rystad Energy, the fall in global capital expenditure in the oil and gas sector amounted to about $215 billion between 2014 and 2015—about 1.2 percent of global fixed capital formation (or just below 0.3 percent of global GDP).
- Some oil importers, notably the United States, have been hit hard by the drop in energy-related investment and account for a significant part of the global drop in investment.
Domestic demand in oil importers
- Advanced oil-importing economies have seen some positive effects on consumption (for instance, in the euro area), but impacts have been less than anticipated.
- Investment growth in importers has fallen short of expectations, in part due to the large decline in U.S. energy-related investment.
- Emerging and developing oil importers:
- Typically have more limited pass-through from international to domestic fuel prices compared with advanced economies.
- Some have reduced fuel subsidies.
- Governments’ improved fiscal positions should eventually result in lower taxes or increased public spending, but the process could take time and is subject to frictions and leakages.
- Overall, domestic demand growth in oil importers was broadly in line with expectations for 2015.
Macro effects near the zero lower bound
- A key difference from past oil-price episodes is that many advanced economies have nominal interest rates at or near zero.
- Lower oil prices reduce production costs and inflation (actual and expected); when policy interest rates cannot be lowered further, the decline in inflation raises the real interest rate, compressing demand and potentially stifling increases in output and employment.
- Chart evidence is suggestive of a depressing effect of low expected oil prices on expected inflation: a strong direct relationship between U.S. oil futures prices and a market-based measure of long-term inflation expectations.
- Being near the zero bound can imply a perverse response to higher oil prices: when central banks aim to counter deflation pressures, they are unlikely to raise policy interest rates aggressively in response to an uptick in inflation, so oil price increases can be expansionary by lowering the real interest rate.
- Central banks should not raise policy interest rates to try to enhance benefits of low oil prices; raising nominal rates would, all else equal, harm growth by raising real interest rates.
Risks, potential dislocations, and policy implications
- Persistently low oil prices complicate monetary policy and risk further inroads by unanchored inflation expectations.
- The current episode of historically low oil prices could ignite a variety of dislocations including corporate and sovereign defaults and financial-market feedback loops.
- The possibility of negative feedback loops makes global demand support, combined with country-specific structural and financial-sector reforms, especially urgent.
- Policy priorities include:
- Global demand support by the international community where needed.
- Country-specific structural reforms to boost potential growth.
- Financial-sector measures to contain and manage corporate and sovereign distress.
Key statistics and dated observations (preserved exactly as in source)
- Date of post: March 24, 2016.
- Since June 2014 oil prices have dropped about 65 percent in U.S. dollar terms (about $70).
- Dollar appreciation during this period: 20 percent (in nominal effective terms).
- Average decline in local currency: over $60.
- Share of global GDP for oil exporters: about 12 percent.
- Fall in global capital expenditure in the oil and gas sector between 2014 and 2015: about $215 billion.
- This fall equals about 1.2 percent of global fixed capital formation (or just below 0.3 percent of global GDP).
- Correlation change noted: since August 2015 the simple correlation between equity and oil prices has doubled compared with an earlier period starting in August 2014.
- Comparative reference: forthcoming April 2016 World Economic Outlook analyses 2015 domestic demand versus April 2015 expectations.
Source: IMF blog post "Oil Prices and the Global Economy: It's Complicated", March 24, 2016.
Content in this bundle
- Staff Discussion Note