Do oil price spikes cause recessions? It is a controversial question and one that is very much a propos. It is all very chicken-and-egg, of course. If oil is soaring because of overheating economic demand, is it the demand or the ensuing rise in oil prices that causes the crash?
Britain’s Centre for Economic Policy Research has had a go at trying to answer this with a report written by Natalie Chen and Andrew Oswald from the University of Warwick and Liam Graham from University College London. The twist was that the academics used terrorist incidents as an instrumental variable. Roughly, they looked at the impact of a sharp rise in oil prices on the profitability of various industries. By using terrorist events, they stripped out macroeconomic drivers and focused on something that was separate from the business cycle.
The researchers say their findings are not definitive but that they “lend” support to the claim that oil-price spikes can be a source of recessions. They urge caution, however, in the absence of study on the impact of microeconomic mechanisms linking oil to recessions. That may be the key to unravelling the oil-macroeconomy relationship, they conclude.