Business cycles in the USA: the role of monetary policy and oil shocks

Abstract

This paper examines the relative significance of oil supply, oil demand, and monetary policy shocks in explaining US macroeconomic variations. We analyze impulse response functions and variance decomposition to assess the relative importance of these shocks. Using a Bayesian structural VAR framework and the penalty function approach, we identify the shocks of interest. We find that oil supply shocks explain less than 3% of the variation in output, but have a relatively larger impact on inflation, accounting for around 13% of the inflation variation. Oil demand shocks explain 3% of output variation, but contribute significantly to inflation variation (around 16%). In contrast, monetary policy shocks have a greater influence on output, explaining approximately 13% of the observed variation. Monetary policy shocks are also the most influential source of inflation variation, contributing over 24% to the overall variation. Based on historical variance decomposition, we find that the recent inflation surge is attributable to both monetary expansion and oil supply factors. Overall, the study highlights the dominance of monetary policy shocks in explaining US macroeconomic fluctuations, with oil supply and demand shocks playing secondary roles.