Oil price shocks and macroeconomic dynamics: How important is the role of nonlinearity?

This study examines the state-dependent effects of crude oil price shocks on the US aggregate economy. Using a smooth transition vector autoregressive model, we assess the effects of normalized supply and demand shocks in the global oil market over the different phases of the business cycle. Our findings show that the link between oil prices and macroeconomic dynamics is nonlinear and that structural shocks in the oil market conditional on recessions have a greater and more persistent contractionary impact on macroeconomic variables including industrial production, employment, and consumer price inflation. Forecast error variance decomposition confirms that oil prices have much stronger stagflationary effects during recessions.