Oil prices and the economy: A global perspective

Abstract

This paper investigates the relationship between oil prices and the global economy. In modelling this relationship, a new approach is proposed in which we introduce the use of a factor error correction model to compress data from the largest developed and developing economies. An important feature of this model is that at global level, we find that global money, output and prices are cointegrated, which is supportive of the quantity theory of money. Positive innovation in global oil price is connected with global interest rate tightening. Positive innovation in global money, CPI and outputs is connected with an increase in oil prices while positive innovations in global interest rate are associated with a decline in oil prices. The US, Euro area and China variables are the main drivers of global factor