Crude oil price shocks, monetary policy, and China's economy

• Author: Yue‐Jun Zhang,Can Yang,Fenghua Wen,Feng Min
• DOI: http://doi.org/10.1002/ijfe.1692
• Published date: 01 April 2019
• Date: 01 April 2019

RESEARCH ARTICLE

Crude oil price shocks, monetary policy, and China's economy

Fenghua Wen

1,2,5

| Feng Min

1

| Yue‐Jun Zhang

3,4

| Can Yang

1

1

School of Business, Central South

University, Changsha, China

2

Supply Chain and Logistics Optimization

Research Centre, Department of

Mechanical, Automotive and Materials

Engineering, University of Windsor,

Windsor, ON, Canada

3

Business School, Hunan University,

Changsha, China

4

Center for Resource and Environmental

Management, Hunan University,

Changsha, China

5

Financial Research Institute, Wenzhou

University, Wenzhou, China

Correspondence

Yue‐Jun Zhang, Business School, Center

for Resource and Environmental

Management, Hunan University,

Changsha 410082, China.

Email: zyjmis@126.com

Funding information

Changjiang Scholars Program of the Min-

istry of Education, Grant/Award Number:

Q2016154; China Scholarship Council,

Grant/Award Number: 201606135020;

Hunan Youth Talent Program; National

Natural Science Foundation of China,

Grant/Award Numbers: 71774051,

71633006, 71431008, 71371195, 71322103

and 71273028; Fundamental Research

Funds for the Central Universities;

National Program for Support of Top‐

notch Young Professionals, Grant/Award

Number: W02070325

Abstract

This paper develops a time‐varying parameter vector autoregressive model to

examine the dynamic effects of crude oil prices and monetary policy on China's

economy during January 1996 to June 2017. The empirical results indicate that

(a) in general, international crude oil price shocks have positive effect on

China's economic growth and inflation in the short run, but the long‐run effect

appears diverse; (b) China's monetary policy shocks have positive effect on the

economic growth and inflation overall; specifically, an increase in monetary

supply can partly offset crude oil prices' negative effect on China's economic

growth; (c) China's monetary policy has positive effect on crude oil prices

and plays an important role in the relationship between crude oil price shocks

and economy; and (d) during the recent global financial crisis, crude oil price

shocks produce greater negative effect on China's economic growth, whereas

the long‐run effect of monetary policy on China's economic growth proves

weaker, compared with other periods.

KEYWORDS

China's economy, crude oil price shocks, monetary policy, time‐varying effect, TVP‐VAR model

1|INTRODUCTION

Changes in international crude oil price and theireffects on

macroeconomic performance have always been of interest

to researchers and policy makers, for oil is one of the most

important global energies and plays an important role in

economic development (Zhang & Chen, 2018). Since the

crude oil crisis in the 1970s, many scholars have studied

the relationship between crude oil price shocks and

macroeconomic variables and have made great strides in

understanding the relationship. However, the impact of

crude oil price shocks on macroeconomic variables is

unstable over time, bringing a great challenge to the

analysis of the relationship between crude oil prices and

economy. For example, Hamilton (1983) discovers that a

dramatic increase in crude oil prices tended to be followed

Received: 15 March 2018 Revised: 17 July 2018 Accepted: 10 September 2018

DOI: 10.1002/ijfe.1692

812 © 2018 John Wiley & Sons, Ltd. Int J Fin Econ. 2019;24:812–827.wileyonlinelibrary.com/journal/ijfe

by output declines over the period 1948–1972. He believes

that crude oil price shock is one of the factors that caused

some of U.S. recessions. However, from then on, the oil

price–macroeconomy relationship has changed. The rapid

increase in the prices of oil need not result in sustained

inflation or stagflation in real GDP (Barsky & Kilian,

2004). Kilian (2008) finds that in general, the impact of oil

shocks on the U.S. economy has been very limited since

the 1970s.

Moreover, regarding whether crude oil price shocks

generate asymmetric impact on economic growth,

scholars hold varying views. For example, Cunado and

de Gracia (2003) note that oil price changes have short

run but asymmetric effect on economic activity among

the European countries they studied. Hamilton (2003)

demonstrates that an increase in crude oil prices could

affect the economy but a decrease in crude oil prices

could not. However, Kilian and Vigfusson (2011) and

Herrera, Lagalo, and Wada (2015) hold a different view.

They argue that industrial output's responses to oil price

shocks are symmetric. The aforementioned literatures

on the oil price–macroeconomy relationship suggest that

the relationship between crude oil price shocks and

economy proves complex and that the effects of crude

oil price shocks on the economic activity vary over time.

Crude oil price shocks generate different effects on the

economy not only at different times but also on different

national economies. Some studies (among others, Cashin,

Mohaddes, Raissi, & Raissi, 2014; Cavalcanti & Jalles,

2013; Korhonen & Ledyaeva, 2010; Peersman & Van

Robays, 2012) indicate that oil price shocks have varying

effect on the economic activities of crude oil exporting

and importing countries. Even if some countries belong

to the same category of crude oil importing or oil exporting

countries, oil price shocks would generate different effects

on their economic growth (see,e.g., Jiménez‐Rodríguez &

Sánchez, 2005; Korhonen & Ledyaeva, 2010). Aastveit,

Bjørnland, and Thorsrud (2015) indicate that countries in

Europe and North America suffer more than countries

in Asia and South America under the impact of an

adverse oil market by using a factor‐augmented vector

autoregressive approach. These findings demonstrate that

in different countries and regions, the impacts of crude oil

price shocks on the economic activity are quite different.

Due to the differences in the research conclusions for

different countries, the findings about other countries

can only provide limited guidance when analysing the

impact of crude oil price shocks on a particular country's

economy.

As for the complex impact of crude oil price shocks

on macroeconomic activities, one candidate reason is

that crude oil prices have diverse drivers. Kilian (2009)

considers aggregate demand and precautionary demand

for crude oil; oil supply disruptions are three main drivers

for oil price fluctuations. Some studies (e.g., Salisu &

Fasanya, 2013; Wen, Gong, & Cai, 2016; Wen, Xiao,

Huang, & Xia, 2018) argue that structural breaks in crude

oil market may result from a lot of factors such as

regional conflicts, financial crisis, market regulation,

and technological developments in new energy industry.

Baumeister and Kilian (2016) believe that factors such

as oil‐exporting countries' political events, the uncertainty

of global economic cycle, and changes in expectations

can cause oil price fluctuations. In addition, investor

behaviour, such as investor attention (Li, Ma, Wang, &

Zhang, 2015; Yao, Zhang, & Ma, 2017), investor sentiment

or stock market risk aversion (Zhang, Chevallier, &

Guesmi, 2017), and speculative trading activity (e.g.,

Cifarelli & Paladino, 2010; Juvenal & Petrella, 2015;

Wen, He, Dai, & Yang, 2014; Zhang, 2013; Zhang &

Yao, 2016), plays an important role in the changes in oil

prices. To further complicate matters, the main factors

that drive oil price as well as the probability these factors

occur might also change over time. Hamilton (2009)

argues that real prices of oil are dominated by different

regimes at different times. Fan and Xu (2011) find that

the main drivers of oil prices and their way of influence

are much different in different periods. Zhang and Zhang

(2015) find that the transition probabilities of different

crude oil price regimes might vary in different time

periods. What is more, the effect of crude oil prices on

the economic activity also changes over time. For

example, in the 1970s, a rapid increase in oil prices is

followed by a substantial decline in economic output

and a rise in inflation, whereas in the 2000s, a large

increase in crude oil prices only have a mild effect

(Blanchard & Riggi, 2013). Researchers have offered a

number of possible explanations as to what cause the

crude oil prices to generate varying effect on the

macroeconomic aggregates. Primiceri (2005) holds the

opinion that the transmission mechanism as well as the

volatility of exogenous shocks can change over time, and

Koop, Leon‐Gonzalez, and Strachan (2009) further

confirm that those changes are gradual as opposed to

being abrupt. Blanchard and Galí (2010) believe that the

varying effect of oil price shocks is due to a change in

the causal relation between oil prices and macroeconomic

aggregates. Peersman and Van Robays (2012) affirm that

the degree of improvement in energy dependence is one

of the most important reasons. Blanchard and Riggi

(2013) discover that the declining share of crude oil in

production and consumption, the reduction in real wage

rigidity, and better monetary policy are the reasons for

the changes in causal relationship.

In summary, the diversity of the driving factors of

crude oil prices, the changes in their driving effect of

WEN ET AL.813