Oil and the Macroeconomy When Prices Go Up and Down: An Extension of Hamilton's Results

Author(s): Knut Anton Mork

Source: Journal of Political Economy, Vol. 97, No. 3 (Jun., 1989), pp. 740-744
Published by: The University of Chicago Press
Stable URL: http://www.jstor.org/stable/1830464 .
Accessed: 22/07/2013 04:43

Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at .
http://www.jstor.org/page/info/about/policies/terms.jsp

.
JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of
content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms
of scholarship. For more information about JSTOR, please contact support@jstor.org.

The University of Chicago Press is collaborating with JSTOR to digitize, preserve and extend access to Journal
of Political Economy.

http://www.jstor.org

This content downloaded from 206.212.0.156 on Mon, 22 Jul 2013 04:43:28 AM

All use subject to JSTOR Terms and Conditions
Confirmations and Contradictions

Oil and the Macroeconomy

When Prices Go Up and Down:
An Extension of Hamilton's Results
Knut Anton Mork
VanderbiltUniversity

Om jeg hamrer eller hamres, like fullt sa' skal der

jamres. (If I beat or if I'm beaten-either way you start
your howling.) [IBSEN, Peer Gynt; trans. Peter Watts]

In an important paper, Hamilton (1983) demonstrated a strong cor-

relation between oil price changes and gross national product growth
in U.S. data. However, his study pertained to a period in which all the
large oil price movements were upward, and thus it left unanswered
the question whether the correlation persists in periods of price de-
cline. Moreover, the price variable he used was somewhat distorted by
price controls in the 1970s. This note investigates whether Hamilton's
results continue to hold when the sample is extended to include the
recent oil market collapse and the oil price variable is corrected for
the effects of price controls. Particular attention is given to the possi-
bility of asymmetric responses to oil price increases and decreases, as
suggested in the structural employment literature (Loungani 1986;
Davis 1987; Hamilton 1988).
Like Hamilton, I based my investigation on the GNP equation in
Sims's (1 980b) six-variable quarterly vector autoregressive model,

I have benefited from comments by Michael R. Darby, Robert E. Hall, James D.

Hamilton, 0ystein Olsen, Sam Peltzman, William Roberds, Alan Stockman, James A.
Wilcox, and an anonymous referee, as well as the audiences of the American Economic
Association, the Norwegian Economic Association, the Central Bureau of Statistics of
Norway, and the Federal Reserve Bank of Atlanta. Financial support by the Dean's
Fund for Research, Owen Graduate School of Management, Vanderbilt University, is
gratefully acknowledged. Soo-Bong Uh provided valuable research assistance.
Journal of Political Economy, 1989, vol. 97, no. 3]
? 1989 by The University of Chicago. All rights reserved. 0022-3808/89/9703-0011$01.50

740

This content downloaded from 206.212.0.156 on Mon, 22 Jul 2013 04:43:28 AM

All use subject to JSTOR Terms and Conditions
CONFIRMATIONS AND CONTRADICTIONS 741

with modifications as explained below. My strategy is as follows. First,

I add the real price of oil to the six-variable equation and test to see if'
this variable continues to add significantly to its fit when the sample is
extended through the middle of 1988 and the price variable is cor-
rected for controls. Second, I test this specification for stability of the
coefficients before and after the collapse of the oil market in 1985-
86. Third, I allow for an asymmetric response to oil price changes by
specifying real price increases and decreases as separate variables and
test (a) the individual significance of the two variables thus defined, (b)
the symmetry of the responses, and (c) the stability of this specification
over the sample.
The dependent variable of the model was specified as 400 times the
log change in GNP in 1982 dollars. The variables on the right were
entered as lags from one to four quarters. Apart from a constant and
the oil price variables, they were 400 times the log change in the GNP
deflator, the deflator for imports, average hourly earnings for pro-
duction workers in manufacturing, and real GNP itself; and the levels
of the civilian unemployment rate and the 90-day Treasury bill rate.'
Data availability and the four-quarter lags defined the estimation sam-
ple as 1949: 1-1988:2.
Hamilton used the producer price index (PPI) for crude oil. During
the price controls of' the 1970s, this index is misleading because it
reflects only the controlled prices of domestically produced oil. How-
ever, since the price control system closely resembled a combined tax/
subsidy scheme for domestic and imported crude oil, the marginal
cost of crude to U.S. refiners can be approximated by the composite
(for domestic and imported) refiner acquisition cost (RAC) for crude
oil.2 The RAC figures are available monthly starting in January 1974
and annually going back a few more years. I reconstructed the log
differences of the refiner prices as follows. For 1971: 2 (the last quar-
ter before the Nixon price controls) and earlier quarters, I used the
rate of change of the PPI. For 1974: 2 and subsequent quarters, I
used the rate of change of the RAC. For 1971:3-1974: 1, I used the
quarterly rate of change for the PPI, multiplied by the ratio of' the
1970-74 change in the annual log RAC to the corresponding change
in the annual log PPI. The resulting index is available from the au-
thor on request.3

1
I followed Sims (1 980a) in substituting this variable for Ni1, which was used in his
original model (Sims 1980b).
2
The entitlement system in effect required refiners to buy foreign and domestic oil
in fixed proportions so that, by duality, the aggregate price for the two types of oil was a
linear average.
3 For this variable, as well as the others for which monthly data were available, I used

the change from midmonth to midmonth so as to minimize time aggregation.

This content downloaded from 206.212.0.156 on Mon, 22 Jul 2013 04:43:28 AM

All use subject to JSTOR Terms and Conditions
742 JOURNAL OF POLITICAL ECONOMY

TABLE 1
RE(,RESSION RESULTS FOR REAL GNP GROWTH, INCLUDING REAL OIL PRICE CHANGES

LAG COEFFICIENTS Ex(CL.US

ION TESTS

VARIABLE 1 2 3 4 F(4, 133) p-Value

Real GNP growth .114 .236 -.007 .054 1.380 .244
(.104) (.113) (.115) (.097)
Inflation, GNP .284 .265 -.112 .072 1.498 .207
deflator (.163) (.185) (.181) (.182)
3-month Treasury .050 - 1.163 .904 - .399 4.608 .002
bill rate (.383) (.519) (.535) (.407)
Unemployment rate -.617 1.993 .952 - 1.439 4.360 .002
(1.039) (1.327) (1.316) (.984)
Wage inflation, aver- -.031 -.182 -.025 -..069 .968 .428
age hourly earnings (.100) (.098) ( 101) (.098)
manufacturing pro-
duLction workers
Import price infla- .025 -.079 .066 .023 .656 .624
tion, implicit (.056) (.062) (.063) (.055)
deflator
Real oil price changes -.011 .019 -.017 -.029 2.211 .071
(.015) (.016) (.016) (.014)
NOTE.-Standard errors are in parertheses. Constant - -..088 (1.655); R' = .459; standard error of the
regression = 3.608. For the test of stability between 1949: 1- 1986:1 and 1986:2-1988:2, F(9, 120) = 2.189; p-
value = .027.

Estimation of the six-variable model without oil produced an R2 of

.422 and a standard error of the regression of 3.673. The parameter
estimates for this specification, which are of limited interest, are not
presented.
The purpose of the stability test is to see whether the same model
fits before and after the oil market collapse in late 1985. For the
quarterly oil price index used here, the first large price decline occurs
during 1986: 1. Because of the lags in the model, the effect of this
decline could have been seen at the earliest for 1986: 2. Thus the test
is for stability of the parameters across the two subsamples 1949: 1-
1986: 1 and 1986:2-1988:2.4 The result was an F(9, 124) of .346
with an accompanying p-value of .957. Thus this specification has no
difficulty passing the stability test.
Table 1 presents the results obtained when the log changes (multi-
plied by 400) in the price control-corrected real price-5of crude oil
are added to the model. These results are weaker than Hamilton's.

-I I use the test statistic derived by Chow (1960) and Fisher (1970) when the second
period has fewer observations than parameters in the model.
' Hamilton uses the nominal price, which gives the same results as long as the
deflator is included as a separate variable. For distinction between price increases and
decreases, only the deflated price seems meaningful.

This content downloaded from 206.212.0.156 on Mon, 22 Jul 2013 04:43:28 AM

All use subject to JSTOR Terms and Conditions
CONFIRMATIONS AND CONTRADICTIONS 743
TABLE 2
REGRESSION RESULTS FOR REAL GNP GROWTH, INCLUDING
REAL OIL PRICE INCREASES AND DECREASES

LAG COEFFICIENTS EXCLUSION TESTS

VARIABLE 1 2 3 4 F(4, 125) p-Value

Real oil price increases - .031 -.015 - .049 - .049 4.681 .001
(.022) (.021) (.020) (.019)
Real oil price decreases -.003 .037 .010 -.027 1.710 .152
(.020) (.026) (.027) (.023)
NOTE.-R2 = .518; standard error of regression = 3.461. For the test of pairwise equality of coefficients for real
oil price increases and decreases, F(4, 125) = 3.794; p-value = .006. For the test of stability between 1949: 1-1986: 1
and 1986:2-1988:2,F(9, 116) = 1.197; p-value = .304.

Although all but one of the coefficients are negative, they are rather
close to zero. Taken together, the coefficients are only borderline
significant from zero, with a p-value of .071, compared to .0003 in
Hamilton's paper. However, the stability test leads to a quite convinc-
ing rejection with a p-value of .027. This rejection suggests that the
behavior of GNP growth indeed is correlated with the state of the oil
market.6
When this exercise was repeated with the PPI without correction
for price controls, the results were much weaker, with p-values of .140
and .188 for the exclusion and stability tests, respectively. Apparently,
the price control correction makes a substantial difference.
Table 2 pursues the stability issue by allowing for asymmetric ef-
fects of oil price increases.7 Specifically, this is done by defining two
variables for oil price changes, where either one equals the real price
change when the latter is positive or negative, respectively, and zero
otherwise. The results now strongly confirm a large negative effect of
oil price increases. All the coefficients are negative, and two are
significant individually at the 5 percent level. Their sum is as large as
-.144, and the exclusion test for this variable leads to rejection with a
convincing p-value of .00 1.
The coefficients for price declines, on the other hand, are smaller
and of varying signs. Their sum is a slightly positive .017. The p-value
for the exclusion test is .152, which would not lead to rejection at
normal significance levels. Thus these data do not identify any

6
Various attempts were made to remove this instability by accounting for the lower
ratio of oil consumption or oil imports to GNP since the mid-1970s, measurement
effects on GNP with changing terms of trade, and the anticipated/unanticipated and
permanent/transitory distinctions for oil price changes. All the attempts were unsuc-
cessful within the model of symmetric responses.
7 The parameter estimates for the nonoil variables were almost identical to those in

table 1 and are not presented.

This content downloaded from 206.212.0.156 on Mon, 22 Jul 2013 04:43:28 AM

All use subject to JSTOR Terms and Conditions
744 JOURNAL OF POLITICAL ECONOMY

significant effects of oil price declines. They do show convincing evi-

dence, however, that the effects of oil price declines are different
from those of price increases. A formal test of pairwise equality of
their coefficients leads to rejection with a p-value of .006, as shown in
the note to table 2. This result contrasts with Tatom (1988), but his
sample ends in 1986: 3. Finally, the asymmetric specification passes
the stability test with a p-value of .304.
These results confirm that the negative correlation with oil price
increases is not an artifact of Hamilton's data. They persist in the
longer sample and are strengthened by the correction for price con-
trols. On the other hand, an asymmetry in the responses is quite
apparent in that the correlation with price decreases is significantly
different and perhaps zero. A theoretical rationale for this asym-
metry is offered in Hamilton (1988). Further research is needed to
verify this view empirically.

References
Chow, Gregory C. "Tests of Equality between Sets of Coefficients in Two
Linear Regressions." Econometrica28 (July 1960): 591-605.
Davis, Steven J. "Allocative Disturbances and Specific Capital in Real Business
Cycle Theories." A.E.R. Papers and Proc. 77 (May 1987): 326-32.
Fisher, Franklin M. "Tests of Equality between Sets of Coefficients in Two
Linear Regressions: An Expository Note." Econometrica38 (March 1970):
361-66.
Hamilton, James D. "Oil and the Macroeconomy since World War II." J.P.E.
91 (April 1983): 228-48.
"A Neoclassical Model of Unemployment and the Business Cycle."
J.P.E. 96 (June 1988): 593-617.
Loungani, Prakash. "Oil Price Shocks and the Dispersion Hypothesis." Rev.
Econ. and Statis. 68 (August 1986): 536-39.
Sims, Christopher A. "Comparison of Interwar and Postwar Business Cycles:
Monetarism Reconsidered." A.E.R. Papers and Proc. 70 (May 1980): 250-
57. (a)
. "Macroeconomics and Reality." Econometrica48 (January 1q80): 1-
48. (b)
Tatom, John A. "Are the Macroeconomic Effects of Oil Price Changes Sym-
metric?"Carnegie-RochesterConf. Ser. Public Policy 28 (Spring 1988): 325-68.

This content downloaded from 206.212.0.156 on Mon, 22 Jul 2013 04:43:28 AM

All use subject to JSTOR Terms and Conditions