Bao H. Nguyen (Australian National University): On the China factor in international oil markets: A regime switching approach

Bao H. Nguyen (Australian National University) - On the China factor in international oil markets: A regime switching approach

Co-authors: Jamie L. Cross (BI Norwegian Business School) and Chenghan Hou (Hunan University)

Abstract

Our objective in this paper is to investigate the relationship between world oil markets and China’s macroeconomic performance. We start by disentangling the demand for oil stemming from China and the rest of the world. We then propose a sufficiently large set of dynamic VAR models to distinguish between abrupt and gradual changes in the macroeconomic relationships and volatility clustering in the shocks. Our analysis yields four results. First, when analyzing the effects of oil market shocks on China’s macroeconomic growth, we find that negative oil supply shocks tend to have significant positive effects, while the effect of both positive oil demand and oil specific demand shocks tend to be negative. Importantly, the signs of these responses then switch during times of US recession. Second, when analyzing dynamics of the world oil price, we find that China specific demand has had statistically significant positive impacts that are especially pronounced during times of US recession. Third, using counterfactual historical decompositions, we find that China has had a positive impact on the oil price over the past two decades. This is further supported by variance decompositions which show that the proportion of variation in the oil price explained by demand from China is around 30 percent over the sample period. Finally, we also find evidence that the recent 2014/15 oil price drop was due to a combination of increased oil supply and decreased demand from China.

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