Macroeconomic Response of Disentangled Oil Price Shocks: Empirical Evidence from Japan

Deploying the extended version of the structural VAR framework of Killian (2009), this paper projects the dynamic effects of oil price shocks on some major macroeconomic aggregates of the 3rd largest energy consuming economy, Japan for the timespan 1996M1-2015M4. For this analysis the innovations are derived from both global oil and foreign exchange markets. Decomposing the oil price shocks into various components, this paper portrays a historical evolution of the structural shocks. The results convey that the macroeconomic components respond differently depending upon the nature of the oil price shock indicating significant variations in transmission mechanisms. Empirically, the non-existing impact of oil supply shocks on the components of Japanese national income identity along with the prominence of global demand and oil market specific speculative shocks have been discovered. Moreover, this research reestablishes the insulated nature of the Japanese economy. At the macro level, the exchange rate shocks are found to be insignificant to generate any response. Gradual reliance on international trade, which is susceptible to external shocks needs to be considered for macro stability.