Oil price uncertainty and the business cycle: Accounting for the influences of global supply and demand within a VAR GARCH-in-mean framework

This paper reinvestigates the influence of oil price uncertainty on real economic activity in the U.S. using a four-variable VAR, GARCH-in-mean, asymmetric BEKK model. In contrast to previous studies in this area, the analysis focuses on business cycle fluctuations and we control for global supply and demand factors that might affect the real price of oil, its volatility as well as the U.S. economy. We find that - even after accounting for these factors - oil price uncertainty still has a highly significant negative influence on the U.S. business cycle. Our computations show that the effect is economically important during several periods, mostly after a significant variance shift in the mid-1980s. We simultaneously estimate the effect on the global business cycle, but find that it is comparatively weak. A battery of robustness checks confirms these results. Finally, significant spillover effects in the GARCH model suggest that oil price volatility is a gauge and channel of transmission of more general macroeconomic shocks and uncertainty. These linkages are particularly strong in case of unexpected bad news.