Oil Prices and the U.S. Economy: Evidence from the stock market

Author Name Willem THORBECKE (Senior Fellow, RIETI)
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Macroeconomy and Low Birthrate/Aging Population (FY2016-FY2019)

The spot price for a barrel of West Texas Intermediate (WTI) crude oil rose from $11 at the end of 1998 to $140 in June 2008. It then fell to $42 in January 2009 as the Global Financial Crisis intensified. It recovered to $113 by April 2011, fell again to $33 in February 2016, rose to over $80 in May 2018, and fell below $50 by the end of 2018. How do oil prices affect the U.S. economy? Have these effects changed since U.S. oil production has soared after the Global Financial Crisis (GFC) (see Figure).

Many argue that negative oil shocks should reduce output in oil-importing countries such as the U.S. or Japan. On the supply side, oil is a factor of production, and an exogenous decrease in oil supply will decrease productivity. Higher energy costs may also decrease capital formation and long run supply. On the demand side, the price elasticity of demand for oil is low and price increases will not cause spending on oil to fall much. Higher oil prices act as a tax on consumers and firms. As oil prices increase, they will reduce spending on other goods and services. In the energy sector, firms producing oil should benefit from higher prices.

The IMF (2014), using its G20 economic model, reported that oil price increases after the GFC would disrupt the macroeconomies of oil-importing countries. It predicted that a 20 percent increase in oil prices would raise inflation in advanced economies by between 0.5 and 0.8 percentage points, lower GDP by between 0.4 and 1.9 percent, and decrease aggregate equity prices by between 3 and 8 percent.

This paper examines how oil prices affect equity prices. One difficulty when investigating this question is that not only can oil prices affect the economy but weakness in the global economy can depress oil prices. In economic jargon, oil prices are endogenous. This paper uses three different strategies to decompose oil price changes into those driven by global demand factors and those driven by oil supply factors.

Using all three approaches, the results indicate that oil price increases driven by demand and supply factors raised returns on energy sector stocks such as oil and gas production and distribution both before and after the GFC and lowered returns on consumer stocks such as hotels, airlines, restaurants, bars, and retail stores; however, consumer stocks appeared to be harmed less by higher oil prices after the GFC.

Before the GFC many other stocks and the overall stock market were harmed by higher oil prices. After the crisis, however, very few stocks were harmed and aggregate stocks even benefited from higher oil prices. Supply-driven oil price increases in particular lowered U.S. stock returns before the crisis in sectors including industrial machinery, industrial engineering, chemicals, and marine transport but raised them in these sectors after the crisis. Overall, these findings contradict the predictions of the IMF (2014) that higher oil prices will harm the U.S. macroeconomy and lower U.S. stock prices after the GFC.

A finding by Melek (2018) could explain why higher oil prices are good for the industrial machinery sector after the crisis but not before. She reported that increased investment by oil producing firms triggered more investment by non-oil producing firms after the Shale Revolution in America but not before.

Black (1987, pp. 113) observed that "The sector-by-sector behavior of stocks is useful in predicting sector-by-sector changes in output, profits, or investment. When stocks in a given sector go up, more often than not that sector will show a rise in sales, earnings, and outlays for plant and equipment." Future research should investigate how oil price changes affected sectoral output, profits, and investment before and after the Global Financial Crisis. It should also investigate whether consumers' marginal propensity to spend windfall gains from lower oil prices has decreased after the crisis. Finally, it should investigate the mechanisms causing increased investment by oil producing companies to trigger investment by non-oil producing companies after the shale boom (see Melek, 2018).

Figure. U.S. Crude Oil Production
Figure. U.S. Crude Oil Production
Source: U.S. Energy Information Agency.
  • Black, F. 1987. Business Cycles and Equilibrium. Basil Blackwell, New York.