Impact and Policy Responses To Oil Price Shock in The SEACEN Countries

Piter Abdullah

in Research Studies from South East Asian Central Banks (SEACEN) Research and Training Centre

Abstract: In the last five years, oil prices have escalated with prices reaching their highest level of $77 per barrel in August 2006, or relatively the same level as the second oil price shock at the end of the 1970s. Even though the increasing oil price is significant, the impact on the economy as a whole is not the same as in the earlier oil shock. Whereas the previous oil price shocks had caused a severe economic slowdown in almost all countries, the current oil price shock coincides with the one of most favourable global economy in the past 35 years. The muted impact of oil price shock in the recent times is in part related to the different causes and nature of the shock. While shocks in the 1970s and 1980s were caused mainly by sizeable disruptions to oil supply, the recent oil price shock is caused by both the distortions in the supply side and the rapid increase in demand. To a large extent, the current oil price shock has been driven by unexpectedly buoyant demand for oil, particularly in the US, and by the rapidly growing emerging market countries, especially China which has almost doubled its demand for oil in the past 10 years. In contrast with increase in oil demand, world oil production has stagnated. This unbalanced supply and demand is worsened by lower oil inventories in industrial countries and by transportation bottlenecks both for crude and refined oil products that have increased the pressure on oil tanker rates. Taking into account the increasing world oil demand and geopolitical concerns over the security of future oil supplies, the high oil price is perceived to be persistent in the intermediate future. Similarly, the impact of the recent oil price shock has not been very significant in the SEACEN countries as well. Some of countries such as Korea and Taiwan experienced only a limited disruption during and after the shock. Other countries such as Malaysia and Papua New Guinea benefited as government revenue increased and further improved their economies. One plausible explanation for the limited impact of the oil price shock in Korea and Taiwan is that their economic structures have evolved and are now much less dependent on oil than they were in the 1970s. The decreasing oil dependency in some SEACEN countries to some extent is a result of energy policies enforced by governments in the respective countries and has significantly reduced the impact of the oil price shock to the economy. However, empirical results show that subsidy policies in oil price cannot absorb the impact continually. In some countries such as Indonesia and Thailand, the prolonged higher oil price has increased the subsidy burden on the government budget. With regard monetary policy, empirical results show that in some SEACEN countries, monetary policy indicators to some extent are endogenous to oil price hikes. However, such a response only generates a small portion of the output movement due to oil price shocks. An aggressive monetary policy response to an oil price hike would not have succeeded in averting the downturn of the economy. Considering the limited role of monetary policy to economic growth, in anticipation of oil price shocks, monetary authorities would do better to focus their policies on the second round effect rather than on the first round effect of the oil shock. Since domestic oil prices in most countries are determined directly by the international oil price market, the first round effect of such an oil price hike on inflation are likely to be small. However, the second round effect of that oil price hike could be higher and therefore should be estimated appropriately.

Date: 2007
ISBN: 983-9478-58-3
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