Empirical Project

Econometrics ECON 550

Rayhan Mahmood, Emma Mitchell, Tahmeed Jawad

1.Introduction

Since World War Two, it has been interesting to notice that 9 out of 10 recession

came right after an unexpected and rather large increase in the price of oil. Is this just a

coincidence? To many of us, we know oil prices are the foundation of inflation as well as

economic growth. But to what extent do oil prices affect the world?

Several pieces of literature exist to ascertain the impact of oil prices on the U.S.

economy. Change in oil prices can affect the economy through inflation, GDP,

exchange rate, and balance of trades. Government spending and investments depend

on oil prices. Our analysis, thus, examines the demand and supply-side determinants of

oil price instead of direct analysis on the oil price itself. So, we are going to eventually

examine the effect of oil demand or consumption, production or supply, oil reserves on

the U.S. economy which is GDP.

The U.S. economy especially GDP (Baumeister, C. & Kilian, L. 2016) is impacted

by the crude oil prices and this has been studied in this paper. Another study (Gbadebo

A. Oladosu et al, 2018) suggested the effect of oil price elasticity on GDP for net oil-

importing countries, specifically for the U.S. While our research would be motivated to

evaluate oil price shocks over GDP or national income, we would base the analysis to

fathom the effect price determinants on overall national income.

The topic of oil shocks and the United States Economy has been explored

extensively and many like Blanchard and Gald, 2010; Hamilton, 2005; Jones et al.,

2004; and Blanchard and Riggi, 2013; and many others have concluded that major oil

prices increment has affected economies negatively. Some delve a little deeper and

focus on the differences between the impacts of supply and that of demand and even
show to what extent the impact is sensitive. These have stirred up a deeper

conversation on the topic and are explored in Huntington, 2005; Kilian and Lewis, 2011;

and Kilian, 2009. Kilian spearheaded the journey to discover the differences that are

caused by oil shocks to mainly oil-exporting countries and oil-importing countries.

Most existing literature is measured using GDP in comparison to the oil price.

Cologni and Manera, 2008; and Cashin et al., 2013 has shown that the mean elasticity

of GDP usually falls within -5% and 0%. However, the GDP estimates in different

literature are never the same or consistent and this could be because of the areas

(geopolitical) or how serious the oil price shocks or the structure of the economy.

2. Model

The oil price is defined through several factors while various studies suggest that

oil demand, supply, and reserves are the key aspects (Amadeo K., 2021). Hence,

instead of measuring the direct impact of price, we analyzed the effect of oil production,

consumption, and reserves on GDP or equivalently on the macroeconomy of the U.S.

and other 30 countries over the last 30 years. Our model is a simple linear regression

model with dependent variables being GDP and independent variables being oil

consumption, oil production, and oil reserve. The dummy variables we chose were year

and country. The null hypothesis we are testing is as follows:

Ho: Change in price of oil price (Production, Consumption, Reserve) does not affect

GDP.

H1: Change in price of oil price (Production, Consumption, Reserve) affects GDP.
The model looks like this:

GDP = α+β1PROD+ β2CONS+ β3RESRV+µ

3. Data

One of the most daunting tasks of any research is the collection of reasonable

data. The data sources we attempted were OPEC (Organization of the Petroleum

Exporting Countries), Statista, International Energy Agency (IEA), and U.S. Energy

Information Administration (EIA). While all the sources proved to be futile in terms of

data we have been looking for, EIA data sources looked to be quite promising to help

our research. Using EIA sources, we could derive the GDP of thirty countries over thirty

years (1990-2019) including their respective petroleum oil consumption, production, and

reserve.

3.1 Formatting:

First, we renamed and relabeled the variable ‘Country’. Besides, there were a

couple of extra variables that have been dropped. To have consistency in measuring

units of the explained and explanatory variables, new variables have been created in

million terms. The unit of dependent variable GDP measured in billion U.S. dollars has

been converted to million. For explanatory variables, oil production and consumption

reported as quad btu, reserves reported as a billion barrels have all been converted as

million barrels. With regards to the categorical variables’ year and country, we

generated dummy variables. Finally, the missing values in all the variables have been

dropped and number labels have been added to variables.

3.2 Analysis:

The below table provides the summary of the primary features for the final

estimation of the sample for key regressors and the regressed variable:

Table-1: Descriptive Statistics

One of the key aspects of the above summary is that production and

consumption of oil have been close on average while the average reserve was quite

high. Moreover, countries are producing as little as 1.72 million barrels as opposed to

around 5000 million barrels in another country.

3.3 Outliers’ Detection Test:

According to an article published in the University of California Los Angeles

(UCLA), the impact of the outliers on the dependent variable can be conducted through

Cook’s D test.
 Table-2: Descriptive Statistics for Cook’s D Test

A total of 85 observations seems to have an impact on the GDP due to the

existence of outliers in production, consumption, and reserve dataset. For our study, we

used the d cut-off value 2 beyond which we believe GDP is being affected by the

outliers in the regressors.

3.4 Test of Heteroskedasticity:

From another article on Heteroskedasticity by the University of Norte Dame, we

adopted Breusch-Pagan / Cook-Weisberg tests to see whether the residuals are plotted

around the fitted values equivalently. Based on the significance level of 10%, we see

that the residuals are not heteroskedastic as the p-value is 0.06.

Figure-1 below also suggests a similar phenomenon.

 Figure-1: Distribution of Model Residuals

3.5 Test for Differences in Differences (DiD):

Having both regressors and the regressed variables in a panel formation over

multiple periods, we want to test the omission variable bias using DiD method. The

coefficient estimates of the variables are not large enough which tells us that the model

might be suffering from omitted variable bias.

 Table-3: Differences in Differences Test

4. Results/Discussion

Table-3: Model under Ordinary Least Squares (OLS)

The first regression is an Ordinary Least Squares (OLS) model without

robustness. Based on the R squared number of 0.97 we can see the data set fits the

model well. In Table-4, we run a regression of the U.S. only. We can see that the R

squared lowered by a lot. Paying a closer look at the results, we can deduce that oil

production and consumption have quite a significant impact on the GDP considering a

cut-off level of 10% significance. The reserve looks also promising even though it is

marginally over 10% cut-off. What we can estimate from these coefficients is that these

oil price determinants affect the U.S. economy significantly.

 Table-4: Model under Ordinary Least Squares (OLS)- the United States Only

We can see in Table-5 that the oil production and reserve do not impact the GDP

of other countries as they do to the US economy. All data is statistically significant which

signifies that all the price-determining variables have a significant impact on the GDP of

their respective economies.

Table-5: Model under Ordinary Least Squares (OLS)- Outside United States

Considering the outliers based on Cook’s D test, we now define the robust

regression model (rreg) for our OLS model. This will account for the outliers in the

observations by assigning weight to the values in the dataset. While using robust

regression, we are also not required to adopt the heteroskedasticity standard errors

option because the model is not suffering from a heteroskedasticity problem.

 Table-6: Model under Robust Regression

With the adoption of robust regression, we can comment that all the coefficients

for oil production, consumption, and reserve are significant (p-value is smaller than cut-

off 10%) for overall GDP or economy for all the countries.

Table-7: Model under Robust Regression- the United States Only

We can trace the significance of robust regression since the production for the

U.S. has now become statistically significant which was not the case under the OLS

model.
 Table-8: Model under Robust Regression- Outside United States

One important finding is that production has become statistically insignificant

under this model. Other than that, the coefficients for oil consumption and reserve are

significant statistically with a p-value of 0.00.

5. Conclusion

In a nutshell, the research suggests several valuable findings. We reject the null

hypothesis that the change in the price of oil price (Production, Consumption, Reserve)

does not affect GDP. On a global level and in the case of the United States, it finds an

obvious relationship between GDP or national income of a country concerning the oil

production, consumption, and reserves. Apart from the United States, the coefficient of

production is statistically insignificant for the GDP of those countries. This implies that

the United States plays a key role in global oil production and economic prosperity.

However, further research can be conducted in the future to ascertain what factors of

production, consumption, and reserves are fueling these findings on GDP or national

income of U.S. and other economies. Probably at that point, this research paper can

work as a reference to those studies.

6. References

1. Blanchard, O.J., Galí, J., 2010. The Macroeconomic Effects of oil price Shocks.

Int. Dimens. Monet. Policy 2010, 373

2. Blanchard, O.J., Riggi, M., 2013. Why are the 2000s so different from the 1970s?

A structural interpretation of changes in the macroeconomic effects of oil prices.

J. Eur. Econ. Assoc. 11 (5), 1032–1052

3. Gbadebo A. Oladosu, Paul N. Leiby, David C. Bowman, Rocio Uría-Martínez,

Megan M. Johnson (2018). Impacts of oil price shocks on the United States

economy: A meta-analysis of the oil price elasticity of GDP for net oil-importing

economies. Energy Policy, Volume 115, 2018, Pages 523-544, ISSN 0301-4215,

https://doi.org/10.1016/j.enpol.2018.01.032.

4. Cologni, A., Manera, M., 2008. Oil prices, inflation, and interest rates in a

structural cointegrated VAR model for the G-7 countries. Energy Econ. 30 (3),

856–888.

5. Cashin, P., Mohaddes, K., Raissi, M., Raissi, M., 2014. The differential effects of

oil demand and supply shocks on the global economy. Energy Econ. 44, 113–

134

6. Robust Regression | Stata Data Analysis Examples (ucla.edu)

7. https://stats.idre.ucla.edu/stata/dae/robust-regression/
8. Heteroskedasticity (nd.edu) https://www3.nd.edu/~rwilliam/stats2/l25.pdf

9. What Affects Oil Prices? (thebalance.com) https://www.thebalance.com/how-

are-oil-prices-determined-3305650