Monetary Policies and Oil Price Determination: An Empirical Analysis

Abstract

While the oil price shocks of 1970s can be explained by pure supply factors, starting in the 1980s oil prices increasingly began to come under a different type of pressure. Oil prices accelerated from about $35/barrel in 1981 to beyond $111/barrel in 2011. At the same time interest rates subsided from 16.7 per cent per annum to about 0.1. This paper explains how this long-term price increase was, in most cases, caused by expansionary monetary policies that heightened oil prices through interest rate channels. Aggressive monetary policies stimulated oil demand and blew up oil prices, a trend that led to slower economic growth. As for elasticities, the results described in this paper show that oil demand price elasticity is low value and unlike some earlier literature states, supply price elasticity is statistically significant. In last section, the results show that oil prices adjust instantly, declaring the existence of equilibrium in the oil market during the period from 1960 to 2011.