Energy Policy ∎ (∎∎∎∎) ∎∎∎–∎∎∎

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Energy Policy
journal homepage: www.elsevier.com/locate/enpol

International oil shocks and household consumption in China

Dayong Zhang a, David C. Broadstock a,b,n, Hong Cao c
a
Team for Integrated Energy and Environmental Research Studies (TIERS), Southwestern University of Finance and Economics, China
b
Surrey Energy Economics Centre, Department of Economics, University of Surrey, UK
c
Beijing Institute of Technology, School of Management and Economics, China

H I G H L I G H T S

We study the impact of oil price shocks on residential consumption in China.

The most immediate effect passes through expenditure on transportation.

Effects also appear for health, education and food and clothing expenditure.

Existing price regulation offers no great benefit.

We argue that a compelling case for removing current price regulation exists.

art ic l e i nf o a b s t r a c t

Article history: We investigate the impacts that oil price shocks have on residential consumption in China. While it is
Received 14 April 2014 well understood that oil prices affect consumption in a multitude of ways, the timing and directness of
Received in revised form these effects on specific consumption categories is not clear. We demonstrate that the most immediate
22 August 2014
and direct effect passes through transportation consumption, as might be expected. But we also show
Accepted 25 August 2014
that significant effects pass through consumption in other sectors—including “food and clothes”,
“medical expenditure”, and other general “living expenditure”—with less immediacy. Given the results,
Keywords: particularly observed asymmetries with respect to rises and falls in international oil prices, we discuss
Oil shocks some implications for future adjustments to domestic price policies, in particular the case for removal of
Consumption
domestic price regulation.
Residential sector
& 2014 Elsevier Ltd. All rights reserved.
Oil price pass-through

1. Introduction forth policy objectives designed to continue recent economic

“China is now at such a crucial stage that without structural
transformation and upgrading, we will not be able to achieve a
sustained economic growth. In readjusting the structure, the most
important aspect is to expand domestic demand ….”
(Li Keqiang, Summer Davos opening ceremony, September
11th, 2013)1
China has experienced more than 20 years of persistent high-
paced economic growth, driven among other things by continued
corporate and government investment, high levels of exports, and
historically cheap labor. The Chinese government has openly set
n
Correspondence to: Research Institute of Economics and Management,
Southwestern University of Finance and Economics, 55 Guanghuacun Street,
Chengdu 610074, China. Tel.: þ 86 152 0834 0910.
E-mail address: davidbroadstock@swufe.edu.cn (D.C. Broadstock).
1 2
The full speech is available from the Xinhua News Agency at: 〈http://news.
xinhuanet.com/english/china/2013-09/12/c_125371685.htm〉.
trends. 2 There is a general consensus that to complete this process
and further stimulate domestic demand, and by implication the
level of household consumption, China will undergo significant
structural transformation. On the surface, this appears to be a
natural progression for the Chinese economy. Growth in the
demand for all goods and services, however, will necessarily
increase the level of energy consumed in the economy. This
follows immediately from two facts: (a) energy is a critical factor
of production and (b) transportation is required, to a greater or
lesser degree, for the consumption of all goods and services, and
transportation is an energy-intensive (and emissions-intensive)
activity. In this regard, the stated objective of growing domestic
demand is somewhat at odds with targets on the reduction of
emissions and energy consumption that were committed to in the
Chinese government's 12th five-year plan.
This is, for example, a stated objective in the recent 12th five-year plan of the
Chinese government.

http://dx.doi.org/10.1016/j.enpol.2014.08.034
0301-4215/& 2014 Elsevier Ltd. All rights reserved.

Please cite this article as: Zhang, D., et al., International oil shocks and household consumption in China. Energy Policy (2014), http://dx.
doi.org/10.1016/j.enpol.2014.08.034i
2 D. Zhang et al. / Energy Policy ∎ (∎∎∎∎) ∎∎∎–∎∎∎
Growth of the Chinese economy during recent years has
coincided with huge increases in the consumption of oil, under-
pinned by a surge in the rates of private car ownership, which
have increased more than 30-fold, from 0.6 cars per 100 urban
households in 2000 to 18.28 in 2011. The consumption of oil used
for transportation in China doubled in the decade between 2000
and 2010.3 The growth in car ownership increases demand for and
consumption of oil, posing genuine policy concerns since the
domestic consumption of oil far exceeds domestic production.
Although China does produce oil, for many years now the
economy has been a net importer and it is already among the
top three global importers of oil, with 68% of total oil consumed in
2010 being from imported sources. With an oil supply gap that
continues to grow, China is unavoidably affected by international
energy markets, meaning that international oil price shocks can
pass through to domestic activity.
That rising oil prices can impact transportation costs is quite
straight-forward, however there are further mechanisms by which
changing international oil prices can impact upon the wider range
of prices that consumers see. This is discussed in some detail for
the Chinese context by Tang et al. (2010) who, following Brown
and Yucel (2002), attribute the transmission mechanisms in to six
general channels of effect: supply side effects; wealth transfers;
general price inflation; real balance effects (as a result of changes
in the demand for money); sector adjustments/re-structuring; and
effects from increased uncertainty in the oil price. For example, a
rise in the price of oil generates inflation and pushes up the
producer price index—the price faced by industrial consumers—
which is in general then passed on to the consumer via an increase
in the consumer price index—the price that consumers pay. The
price changes will intuitively have some consequence upon the
consumption expenditures of households in the short-run. In
addition, the changing prices will further impact upon firm profits
and investment, leading to lower levels of activity throughout the
economy in the long-run.
To shield domestic consumers against often volatile interna-
tional oil prices, domestic retail oil prices in China are regulated.
The pricing system currently follows a form of floating-peg
regulation (see next section for further detail) against a bundle
of international market prices. The trend of regulation has been to
increasingly normalize domestic prices against a bundle of inter-
national prices, moving from a centrally controlled price in the
1970s toward something today that quite closely reflects a market
mechanism. In light of the rapid growth of car ownership, it stands
to reason that international oil shocks could play an increasingly
important role in domestic household consumption decisions.
Investigating the nature, strength, and timing of these price
pass-through effects therefore seems of interest and relevance to
policy debates, particularly regarding price regulation.
A number of studies, both for China (e.g., Fan et al., 2007; Du
et al., 2010) and elsewhere (e.g., Brown and Yucel, 2002; Hamilton
and Herrera, 2004; Kilian, 2008), have already established the
predominantly negative influence of oil shocks to the macroecon-
omy. However, largely due to data availability, the impact of oil
shocks to household consumption in China has remained an
under-researched phenomenon. This is a significant omission
since it is important to understand the household sector when
considering the welfare implications of exposure to international
oil shocks. In this paper, we therefore aim to assess whether and to
what extent oil shocks pass through to consumption by the
Chinese household sector, looking at aggregate consumption as
3
Similarly, ownership of air conditioning units has increased fourfold, from 30
units per 100 households in 2000 to 121 in 2011 (China statistical yearbook, 2011),
reflecting the increased desire of Chinese households to complement their growing
incomes with high energy–consuming luxury items.
Please cite this article as: Zhang, D., et al., International oil shocks and household consumption in China. Energy Policy (2014), http://dx.
doi.org/10.1016/j.enpol.2014.08.034i
well as consumption within specific expenditure categories,
including “transportation and communication,” “food and cloth-
ing,” “medical expenditure”, “education and entertainment,” and
general “living expenditure.” In this regard, we follow a series of
studies by Mehra and Peterson (2005), Edelstein and Kilian (2009),
Odusami (2010), and Wang (2013), which define the linkages
between international oil shocks and household consumption
under a permanent income hypothesis (PIH).
Considering the results carefully, they indicate that household
consumption expenditure is not adversely affected by rising oil
prices; while falling oil prices seem to stimulate overall consump-
tion to increase. The nuances of these effects, including timing,
asymmetry and transmission routes (through alternative con-
sumption categories) are all interesting, and each discussed in
the main results. But more interesting is that, taken together, our
results point towards the conclusion that lifting the domestic oil
price policy is a very serious option that domestic policy makers
should entertain.
The paper is organized as follows. Section 2 presents a general
background discussion, outlining the nature of the oil pricing
system in China and offering discussion of the literature on oil
shocks and the economy. Section 3 describes the methodology,
establishing the context of the planned consumption model under
a PIH along with the econometric formulation. Data are presented
in Section 4, with the analysis results and discussion offered in
Section 5. The paper concludes in Section 6.
2. Background
Despite an ongoing debate as to the specific role of oil in
shaping household consumption, the general mechanisms by
which it contributes to the economy are reasonably straightfor-
ward. Consider a rise in the price of oil. Scholars widely agree that
oil is needed to support most economic activities, underpinning
the energy requirements of transportation needed to move both
goods and the individuals who provide services. Bhattacharyya
(2011), for example, provides a succinct review of these mechan-
isms, highlighting that a rise in the price of oil effectively increases
the costs of all consumption, thereby reducing the quantity
demanded by consumers for all goods and services. At the same
time, an increase in energy prices makes energy a less desirable
factor of production for firms, causing firms to substitute energy
for other factor inputs, such as capital investment or more labor
intensive production processes, see for example Broadstock et al.
(2007) for a global review of capital-energy substitution or Su
et al. (2012) for a China specific example looking at capital, labor
and energy, where further discussion on such types of substitution
effects is available.
To establish the importance of oil shocks on consumption in
the household sector of China, we first give some context to the
Chinese oil pricing system. In so doing, we firmly establish the
nature of price regulation and that international oil shocks do have
a route through to domestic oil prices. We then provide a more
general discussion of the existing literature on how oil shocks pass
throughout the economy.
2.1. The oil pricing system in China: an overview
China's oil pricing system has gone through three broad phases
since the People's Republic of China was established. The first
phase, which was in place primarily during the purely central
planned political system, ended in 1981. In this phase, the price of
oil was set by the central government, with no scope for interna-
tional prices to pass through.
 D. Zhang et al. / Energy Policy ∎ (∎∎∎∎) ∎∎∎–∎∎∎
Phase two came into force at about the same time that China
initiated market reforms and introduced the famous “open-door”
policy in 1978. Since the reform, all parts of the economic system
in China, including the domestic oil market, have continued to
shift toward a unique system mixing market-based and centrally
planned elements. From 1981 to 1998, a “dual-pricing” system was
used. In this mechanism, a base level of oil production was
required at a fixed price set by the central government; production
beyond this base level enabled domestic oil producers to choose
between (a) selling any remaining oil on the international markets
(exporting) and accepting the international price or (b) accepting a
regulated domestic price. This phase of the system appears to have
been aimed at providing protection for domestic oil producers to
help them establish and grow.
The final phase represented a shift away from a strong protec-
tionist regime and toward a form of floating peg against a bundle
of international prices. This phase has been in place since 1998 but
has seen some revisions to the definition of the international price
peg, see for example Li and Ma (2011, in Chinese). From 1998
onward, price adjustments have been announced by the National
Development and Reform Commission (formerly known as the
National Planning Committee). From June 1998 until 2001, the
Singaporean market price was used as the benchmark peg for
Chinese domestic prices. During 2001, the peg remained attached,
in part, to the Singaporean price, but the basket of oil prices was
expanded to also include Rotterdam and Minas (Indonesian oil)
prices. Most recently, in 2008, the basket was again adjusted to
track against European Brent, Dubai, and Minas oil prices. The
domestic price in China therefore depends on the dynamics of
international crude oil, including taxes and other fees.
The rule by which price adjustments are made is as follows: when
the 22-business-day moving (weighted) average of the basket of
international oil prices changes by more than 4%, domestic Chinese
prices are revised upward or downward accordingly. The nature of
this mechanism means that shocks must, in general, be long-lived to
substantially shift the 22-day moving average; thus, a certain resi-
lience to oil shocks should exist. But if either (a) the shocks are
sufficiently large or (b) multiple increases (or decreases) are sustained,
they can pass through to the economy within less than a month.4
Some have argued that exposure of China to shocks from
international oil markets would not necessarily be a bad thing, as
it may force the industry to be more responsible in cost manage-
ment and create further benefits for industrial structural reform
(Lin and Mou, 2008). However, one must also recognize that, since
1993, China has been a net oil importer, and the pricing policies
discussed above will have played a role in ensuring stable economic
growth and protection for domestic Chinese oil producers.
2.2. Oil shocks and the Chinese economy: existing evidence
Numerous studies characterize the general impact of oil shocks
to the economy, with a growing number dedicated to under-
standing the specific Chinese context. The purpose here is not to
provide a complete review, but rather to recapitulate some of the
key insights of the literature.
The following quote from Hamilton (2009) neatly summarizes
what might be referred to as a stylized fact of oil and the economy:
“… a slowdown in overall consumer spending and a big drop in
consumer sentiment [is] again very much consistent with what
was observed after earlier oil shocks.”
(Hamilton, 2009, pp. 251)
4
In our empirical work, we use quarterly data; thus, shocks can reasonably be
expected to occur with the same time period.
Please cite this article as: Zhang, D., et al., International oil shocks and household consumption in China. Energy Policy (2014), http://dx.
doi.org/10.1016/j.enpol.2014.08.034i
3
The evidence behind this and similar claims is grounded in a
stream of influential studies that have followed from the early
empirical contribution of Hamilton (1983). Over the decades since,
numerous studies—using different methods and concentrating on
different countries from across the world—all reinforce the under-
lying notion that oil shocks are important (see, for example, Mork,
1989; Mork et al., 1994; Lee et al., 1995; Bernanke et al., 1997; Lee and
Ni, 2002; Hamilton, 2003; Kilian, 2008; Kilian and Vigfusson, 2011).
The point of departure among these studies comes by way of debate
around the ways in which oil is important, particularly regarding the
role of asymmetry in shocks (e.g., positive and negative shocks).
Following for example Broadstock et al. (2014)—who study the
relationship between oil prices and financial market performance
in the Asia Pacific Region—we argue that the transmission
mechanism by which international oil price shocks transmit to
domestic consumption expenditure can go through both a direct
channel and an indirect channel. Each of these effects intuitively
revolves around the implied transportation cost resulting from an
oil shock, but account for the nature of consumption across other
product types also. The direct effect derives from the recognition
that people need to travel (and hence use petroleum, which is
made from oil) to travel and work and other places of recreation,
either in a car or for example as a passenger on a bus. An increase
in the price of oil, and hence oil related products, will directly
increase the transportation cost and in turn alter the quantity
demanded/consumption for goods that directly involve transport.
That is to say, following a rise in the cost of the service, a fall in
consumption expenditure would derive directly from a reduction
in the quantity demanded for the service itself.
The indirect channel, is however more complicated, and may
manifest in alternative ways. The first indirect effect may come
through inflationary concerns and/or general income effects.
Bernanke et al. (1997) and Hamilton and Herrera (2004) for
example study the connections between oil shocks and monetary
policy. Their works have stimulated debate on how oil shocks pass
through the real economy. The general idea is that rising oil prices
lead to overall price inflation across all goods and services
(Bernanke et al., 1997), which can motivate the monetary authority
to respond with contractionary measures and in turn cause further
depression in the economy e.g. a spiral effect. In such circum-
stances consumption expenditure would be negatively affected
also. The second source of indirect effect will manifest as a
substitution effect resulting from a rise in the price of oil.
Increasing oil prices will cause transportation costs to raise as
mentioned earlier, accordingly the quantity demanded for goods/
services that have a high transport cost will decrease and in many
cases so will the level of expenditure on these items. For instance
consumers may allocate a higher share of expenditure towards
entertainment in the home (e.g. TV's or movies) as a result of
higher transportation costs.
To date, only a handful of studies concentrate on the household
sector of the economy and the role that oil shocks may have on it.
Recent works include, for example, Mehra and Peterson (2005),
Edelstein and Kilian (2009), Odusami (2010), and Wang (2013). As
one of the most important economies and largest importers of oil
in the world, China inevitably attracts a large amount of research
interest. However, due to limited availability of long-duration time
series data in China, empirical studies on the Chinese context have
been relatively limited until recently.
Fan et al. (2007) provide one the earliest research studies to
concentrate on China. Using a computable general equilibrium
model of the economy, they show that international oil shocks
have a generally negative impact on the Chinese economy,
including reductions in gross domestic product, investment, con-
sumption, and exports. A number of studies have followed,
offering generally supportive evidence. For example, Huang and
4 D. Zhang et al. / Energy Policy ∎ (∎∎∎∎) ∎∎∎–∎∎∎

Guo (2007) find that oil shocks affect the long-term exchange rate by Palumbo et al., 2006) to describe consumption by the household
in China, while Faria et al. (2009) suggest that the export balance sector of the economy. Defining consumption, income, wealth, and
in China is positively linked with international oil prices. Studies the interest rate in real terms as C t , Y t ,W t , and r t , respectively, we
have also begun to highlight the connection to Chinese financial can write the household budget constraint as follows:
markets. Cong et al. (2008) and Broadstock et al. (2012), for W t þ 1 ¼ ð1 þ r t ÞðW t þ Y t  C t Þ; ð1Þ
example, highlight a dynamic relationship between international
oil shocks and stock market behavior in China. such that next-period wealth equals the discounted value of
Tang et al. (2010) offer a more focused discussion, aiming to current-period wealth plus earned income minus any con-
discern explicitly how oil shocks transmit throughout the Chinese sumption expenditure. Assuming a constant real interest rate
economy and to establish whether the six channels suggested by ðr t ¼ r t þ 1 ¼ r Þ and imposing the condition that lim W t þ i =
i-1
Brown and Yucel (2002)—the supply-side shock effect, wealth
ð1 þ rÞi Þ ¼ 0, then, by repeated substitution of the budget constraint,
transfer effect, inflation effect, real balance effect, sector adjust-
current-period wealth is obtained as follows:
ment effect, and unexpected effect—hold for China. Tang et al.
1 Ct þ i 1 Yt þi
(2010) establish a structural vector auto-regression model to show Wt ¼ ∑  ∑ : ð2Þ
i i
that oil shocks reduce output and investment but increase both i ¼ 0 ð1 þ rÞ i ¼ 0 ð1 þ rÞ
inflation and interest rates. They further claim that the effect of an Using the result from Hall (1978) that consumption follows a
oil shock on China's real economy persists for a long time due to martingale process gives EðC t þ 1 Þ ¼ C t ; then, taking the expecta-
the price control policies in place in China. tions of Eq. (2) results in the common form of the PIH:
Du et al. (2010) look more specifically at the impacts of oil

r 1 E Y r
shocks on economic growth. Their analysis demonstrates that t þi
Ct ¼ ∑ þ Wt: ð3Þ
shocks in international oil prices do affect economic growth as ð1 þ rÞ i ¼ 0 ð1 þ rÞi ð1 þ rÞ
well as price inflation in China. Moreover, they provide evidence Assuming a constant growth rate of real income, g, we have
that policy reforms in the price mechanism in China have had EðY t þ 1 Þ ¼ ð1 þ g ÞY t þ ηt þ 1 , where ηt þ 1 is a white noise process.
significant impacts on this relationship, causing structural instabil- Then we have
ity in their empirical model. Ou et al. (2012) offer one of the more
comprehensive empirical studies taking into consideration a total r r 1 ηt þ i
Ct ¼ Yt þ Wt þ ∑ : ð4Þ
of 71 macroeconomic indicators. Using a structural dynamic factor r g ð1 þ rÞ i ¼ 1 ð1 þ rÞ
i

model, they reveal the most probable transmission mechanisms of
oil shocks to the macroeconomy, suggesting that the inflation
effect comes first, followed by supply-side effects and then real
balance effects. To the best of our knowledge, however, no studies
have explicitly targeted the effect of oil shocks upon consumption
expenditure by the residential sector of the economy.
Our research here is in effect a conceptual mix of the works of
Mehra and Peterson (2005) and Edelstein and Kilian (2009). We
ultimately prefer the assumptions/modeling approach of Mehra
and Peterson (2005) which are consistent with the idea that
households, when faced by a rise in oil prices, may reallocate
their consumption patterns within the context of a planned
consumption framework, allowing for important dis-equilibrium
levels of expenditure to appear. One limitation of their study is the
failure to reflect the existence of the “reallocation” effect which
The derivation to this point establishes that a long-run relation-
ship exists between consumption, income, and wealth. Mehra and
Peterson (2005) refer to this as the planned level of consumption,
C pt , expressing it in a simpler form by first taking expectations of
the error term and adding a constant term, leading to the
estimable long-run relationship
C pt ¼ a0 þ a1 Y t þ a2 W t ; ð5Þ
where a1 ¼ ðr=r gÞ and a2 ¼ ðr=ð1 þ rÞÞ. Actual consumption, how-
ever, differs from planned consumption (Campbell and Mankiw,
1989). The short-run dynamics of consumption can therefore be
written in the form of an error correction model:

k
ΔC t ¼ b0 þ b1 C pt 1 C t  1 þ b2 ΔC pt 1 þ ∑ b3s ΔC t  s þμt : ð6Þ
s¼1

may result from a sudden price change. This was one of the major Substituting Eq. (5) into (6), we have
empirical contributions of Edelstein and Kilian (2009), and the
ΔC t ¼ b0 þ b1 ða0 þ a1 Y t þ a2 W t  C t  1 Þ þ b2 Δða0 þ a1 Y t  1
core motivation for wanting to look across the consumption k
categories. The contributions in our study are therefore two-fold: þ a2 W t  1 Þ þ ∑ b3s ΔC t  s þ μt : ð7Þ
first is the conceptual union of the two analytical approaches s¼1

discussed above; second is the application to the Chinese context,
which is desperately in need of empirical evidence. The latter
contribution is quite important, since China is markedly different
from US where: price regulations in China are much more severe
and less transparent; and also because China is undergoing a
gradual process of market liberalization, but at a cautious pace.
Assuming that future income grows constantly relative to the
current level, and that consumers have rational expectations, the
expected value of accumulated and discounted future income
streams is proportional to the current income. Therefore, the
model can be simplified to the following equation:

k
ΔC t ¼ β0 þ β1 C pt 1  C t  1 þ β2 ΔY t  1 þ β 3 ΔW t  1 þ ∑ β4s ΔC t  s þ μt : ð8Þ
s¼1

3. Methodology and empirical framework Eq. (8) is the baseline model used in our analysis to capture the
dynamics of consumption changes. Following Mehra and Peterson
The model used here is based on the “planned consumption” (2005), oil prices are augmented into the short-run equation5:
framework used by Mehra (2001) and Mehra and Peterson (2005).

ΔC t ¼ β0 þ β1 C pt 1  C t  1 þ β2 ΔY t  1 þ β3 ΔW t  1
The empirical framework begins with a general/standard macro- k k
economic specification of (per capita) household consumption, þ ∑ β4s ΔC t  s þ ∑ β5s Δoilt  s þ μt : ð9Þ
where the level of consumption in an economy, C t , is affected by s¼1 s¼1

the existing level of wealth, W t , as well as current and discounted

expected future income, Y t and EðY t þ i Þ, respectively, where 5
Mehra and Peterson (2005) also include interest rates in their model. We also
i ¼ 1; :::; 1. In this regard, the approach therefore applies the considered interest rates but found that they were insignificant in all specifications,
commonly used PIH, which has been used recently (for example, so we do not discuss them further here.

Please cite this article as: Zhang, D., et al., International oil shocks and household consumption in China. Energy Policy (2014), http://dx.
doi.org/10.1016/j.enpol.2014.08.034i
 D. Zhang et al. / Energy Policy ∎ (∎∎∎∎) ∎∎∎–∎∎∎
Table 1
Variables used in the analysis.
Variable Details
names
ΔC t Real consumption growth rate
ΔY t  1 Lagged real disposable income growth rate
ΔW t  1 Lagged real wealth growth rate
dit Changes in the short-term interest rate
oilt Log real Brent price
goilt Δoilt ; Growth rate of real oil price
þ
goilt max{0, goilt }, Positive oil price growth

goilt min{0, goilt }, Negative oil price growth
ECTt The “error correction term”, that is produced as the residual from
estimation of the long-run consumption equation (Eq. (5)).
Eqs. (5) and (9) establish the main equations for the empirical analysis.
The variables used in the analysis are summarized in Table 1.
4. Data
The data on consumption expenditure ðC t Þ, income ðY t Þ, and
wealth ðW t Þ for China are collected from the DATASTREAM
database,6 seasonally adjusted, and then deflated using consumer
price index (base year: 2000). Wealth is defined as per-capita net
worth in constant prices, while labor income captures the current
period disposable income again in per-capita terms, these defini-
tions are the same as Mehra and Peterson (2005). For consumption
expenditure, in addition to the per-capita total consumption (i.e.,
across all goods and services combined), in urban households, we
also have consumption expenditure for some specific consumption
categories, including transportation and communication, food and
clothes, medical expenditure, education and entertainment, and
other living expenditure. The data are collected quarterly, and the
sample covers the first quarter of 2000 through the third quarter
of 2012.
Consistent with most existing studies, for oil prices, we use the
European Brent crude spot price reported in the Energy Informa-
tion Administration's online database. To ensure that the effects of
exchange rates are controlled for, the international oil price is
converted from US dollars into Chinese renminbi. After deflating,
the series is then transformed into a growth rate by taking log
differences. Although the growth rate of oil prices is a commonly
used measure of oil shocks (following Hamilton 2003), to reflect
the potential nonlinearity (asymmetry), we also separate positive
oil price growth and negative oil price growth in our analysis. The
simple logic behind such decompositions is that consumers tend
to react quickly to price falls, being eager to boost their consump-
tion, however as prices rise consumers can be slower to reduce
their consumption, favoring instead to maintain their current level
of consumption (and the lifestyle attached to it) as long as possible
due to habit formation or lock-in effects, see for example Dargay
and Gately (1995).
Regarding the use of European Brent crude prices, from earlier
discussion we know that the actual regulated price of oil in China
includes Brent prices only since 2008, and that other international
prices are also used in determining the domestic price. In principle
6
DATASTREAM is a commercial database that combines a large array of
national and international data collected from official data sources, such as national
statistical bureaus. It is one of the most comprehensive sources of economic and
financial data compiled in a consistent and easy to use manner, which has made it a
widely used source of information in academic research. The DATASTREAM is
provided by Thomson-Reuters and further information can be found at https://
forms.thomsonreuters.com/datastream/.
Please cite this article as: Zhang, D., et al., International oil shocks and household consumption in China. Energy Policy (2014), http://dx.
doi.org/10.1016/j.enpol.2014.08.034i
5
it is possible to construct a regulated domestic price series,
however in practice this is not feasible since the finer details on
the regulation schemes (e.g. the weightings attached to the basket
members) and price revisions made by the NDRC are not perfectly
transparent. Accordingly to create any such series would involve
analyst judgment and make room for incidental errors that could
impact on the statistical results, which is best avoided. Panel A of
Fig. 1 plots a selection of the oil prices that have constituted the
regulated basket over the years, including Minas, Cinta, Brent,
Dubai and for comparison the Chinese Daqing oil price. The
correlations among these series are extremely high, each at 0.99,
with their movements being almost identical in all periods, with
the exception of some modest deviations in 2011–2012. Any
weighted combination, which would require analyst assumptions,
would clearly be virtually identical to any of the individual series,
which require no strong analyst assumptions. Accordingly the use
of Brent prices as an empirical measure of the oil prices relevant to
China does not seem unreasonable.
Panel B of Fig. 1 shows the regulated gasoline price for China's
RON 95 gasoline7 sold in Beijing. Consistent data on regulated
gasoline prices do not cover a sufficiently long time span to include
into our empirical framework, being available from only 2005
onwards as far as we could obtain the data. Nonetheless looking
at these data alongside the oil price series it can be seen that oil and
gasoline prices share some similar trends. Between 2005 and 2008
both series are rising fairly steadily. The 2008 oil price collapse is
reflected in the gasoline prices by a fall also, though admittedly the
fall in the gasoline price is much less dramatic than that of oil
prices.8 From 2008 onwards gasoline price revisions are evidently
more frequent than before 2008, indirectly revealing the additional
flexibility that resulted from the oil pricing scheme revisions that
took place in 2008 also. From 2011 to the end of the sample both oil
and gasoline prices fluctuate mildly around a fairly constant value,
with no strong pattern of price growth or decline. Hence the
variation in gasoline prices are broadly reflected by variation in
international oil prices, as would be expected.
Summary statistics for the untransformed variables are given in
Table 2, and each of the series is plotted in Fig. 2. Table 2 shows
that income has roughly tripled over the 12-year period, and
wealth is five times larger, on average. Total consumption has
increased around two and one-half times, with the most signifi-
cant increase for consumption of transportation, which is almost
five times greater at the end of the sample than at the beginning.
This rapid growth in transport expenditure implies some support
to our earlier claims that oil shocks are becoming increasingly
more relevant.
5. Empirical results
This section presents and discusses the empirical results,
proceeding first by confirming the nature of cointegration among
the variables and thereby justifying the error correction model for
estimation. Following this, aggregate consumption (i.e., making no
distinction among the consumption categories) is modeled using
the short-run equation in (9), and the importance of international
oil shocks is confirmed. The results are then extended to distin-
guish among the specific consumption categories, offering a richer
image of the location and timing of oil shocks.
7
RON stands for research octane number.
8
The reasons for this are not immediately clear, but it seems that the timing of
some limited gasoline price reductions coincide with the end of the oil price
collapse—it might be argued that the regulators exercised some discretion during
this period of oil price collapse, and waited to see how far prices would fall before
revising the domestic price.
6 D. Zhang et al. / Energy Policy ∎ (∎∎∎∎) ∎∎∎–∎∎∎

RON 93 Gasoline price and the Brent crude oil price.

160

Brent oil - Chinese RMB/barrel.

700

Gasoline - Chinese RMB/Liter.

Cinta 10
140
Daqing
Minas
120 Brent 9
600
Dubai
100
8

80 500
7
60
6 400
40

20 5
300

0
99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 2006 2008 2010 2012
Gasoline = Solid line; Oil = Dashed line (second y-axis)

Fig. 1. (A) International oil price comparisons and (B) Domestic gasoline prices in China. (sample periods differ due to data availability). Note: panel A shows the Cinta,
Daqing, Minas, Brent and Dubai international oil prices from 1999 to 2014. Panel B show the Chinese RON 95 gasoline price from 2005 to 2013 and for comparison includes
the (quarterly) Brent oil price series used for estimation.

Fig. 2. Main variables used in the analysis. Note: these plots are for de-trended data in levels and not the estimation-transformed variables.
 D. Zhang et al. / Energy Policy ∎ (∎∎∎∎) ∎∎∎–∎∎∎ 7

Table 2
Descriptive statistics.

Variable Initial value Final value Avg. growth Mean Min. Max.

Income (Y) 1522.79 4809.01 2.26% 2897.54 1552.79 4809.01

Wealth (W) 9749.09 49,553.96 3.25% 25,615.22 9749.09 49,553.96

Consumption variables
Total 1229.07 3220.41 1.93% 2110.65 1229.07 3220.41
Transportation 97.78 484.78 3.20% 269.61 97.78 484.78
Food and clothing 616.86 1521.89 1.81% 996.69 616.40 1521.89
Medical expenditure 77.12 204.71 1.95% 144.89 77.12 207.33
Educ. and ent. 151.33 384.71 1.87% 273.41 151.33 399.84
Other living expenses 108.05 288.45 1.96% 211.54 101.01 292.65

Oil price variables

oilt 222.23 535.99 1.76% 389.56 161.42 716.71
goilt 8.82 1.44 1.90  72.85 28.45
þ 8.82 1.44 6.41 0.00 28.45
goilt

goilt 0 0  4.51  72.85 0.00

Notes: All variables are expressed in real monetary terms except for oil growth, measured in Chinese RMB. Statistics were calculated for data from the first quarter of 2000
through the third quarter of 2012.

Table 3 expressed in a standard linear regression form as follows:

Cointegration and break test results for variables used in the analysis.
yt ¼ μ1 þ μ1 DBt þ α1 xt þ α2 DBt xt þξt ; ð10Þ
Panel I. Cointegration test
Engle and Granger residual-based test where the date break indicator variable, DBt , is the unknown break
point to be estimated and takes the value 1 on and after the
Test statistics Cointegrating vector chosen break date and 0 for all other periods. Gregory and Hansen
nnn
(1996) then suggest a sequential search procedure to identify the
Tau statistic  5.2439 Income 0.9316
Z-statistic  38.0149nnn Wealth 0.0451 most likely breaking point using ADFn and/or Z n statistics, where
  
Johansen approach ADFn ¼ Inf ADFðτÞ ; τ A kmin ; kmax ;

No. of CI vectors Max-Eigen Trace Cointegrating Vector and

  
None 25.9031 nnn
34.4032 nn
Income 1.0622 nn
Z n ¼ Inf Z ðτÞ ; τ A kmin ; kmax ;
At most 1 8.4646 8.5001 Wealth 0.1322nn
At most 2 0.0355 0.0355 and where kmin and kmax are the trimming points from the start
Panel II. Gregory and Hansen break test and end of the full sample, reflecting the fact that a break cannot
happen in either the beginning or ending period of the sample.9
Statistics Breaking point Critical value Gregory and Hansen (1996), Table 1 provide critical values for both
nnn
test statistics. While the above test procedure is not dissimilar
Inf ADF  7.2553 2008Q2 5%  5.96
Inf Z  6.5993nnn 2007Q4 1%  6.45 from alternative procedures, such as Andrews–Ploberger types of
tests, the refinements by Gregory and Hansen (1996) ensure that
nnn
and nn denote significance at the 1% and 5% levels respectively. Note: the test retains power in the context of cointegrating variables/
CI ¼ cointegrating. relationships, making it preferable in our context.
The structural break test results are presented in panel II of
Table 3, and plotted in Fig. 3. According to the ADFn statistic, a
5.1. Testing for the PIH and structural break
structural shift occurred during the second quarter of 2008. This
break date roughly coincides with two events, the global financial
Taking consumption, wealth, and income as defined above,
crisis and the latest revision to the domestic pricing policy. In light
we begin by considering whether their long-run relationships
of the severity of the global financial crisis, we consider this to be
are stable over the estimation sample. To do so, we first
the dominant of the two forces.10
apply standard cointegration checks, including Johansen's
These results point toward a fundamental shift in consumers'
approach and the Engle and Granger residual-based test for
treatment of wealth before and after the structural break, with the
comparison. The results, reported in panel I of Table 3, indicate
sign of the coefficient switching. It appears that the role of the
one cointegrating vector, suggesting that a long-run relationship
financial crisis was to fundamentally alter the long-run expecta-
exists.
tions of consumers, but short-run adjustment behaviors remained
While the results suggest evidence of cointegration and the
unchanged. The long-run equation is therefore modified to reflect
potential to proceed to the estimation of the short-run Eq. (9), it is
this:
nonetheless important to recognize that, among other things,
our sample period incorporates the global financial crisis, which C pt ¼ α0 þ α1 Y t þα3 W t þ DBt ðα0b þα1b Y t þα3b W t Þ: ð11Þ
has been the source of fundamental shifts in economic activity
worldwide. Notwithstanding the existence of a cointegrating
relationship, a structural shift due to the global financial crisis is 9
More precisely, this means that enough observations must exist on both
a distinct possibility. To test the possibility of some significant subsamples, at the start and at the end, to allow the test procedure to produce
accurate results.
structural change in this long-run relationship, we adopt the 10
In the following discussion, we refer to this as a break due to the crisis, but
structural break test proposed by Gregory and Hansen (1996). we concede that it may, in part, also reflect structural change due to policy
They propose a simple model with regime shift that can be adjustment.

Please cite this article as: Zhang, D., et al., International oil shocks and household consumption in China. Energy Policy (2014), http://dx.
doi.org/10.1016/j.enpol.2014.08.034i
8 D. Zhang et al. / Energy Policy ∎ (∎∎∎∎) ∎∎∎–∎∎∎

-4.5

-5.0

-5.5

-6.0

-6.5

-7.0

2002 2004 2006 2008 2010

( Solid line = ADF statistic; Dashed line = Z statistic; Dotted line = 1% critical value )

Fig. 3. Gregory and Hansen (1996) test statistics. Notes: solid line ¼ ADF statistic; dashed line ¼Z statistic; dotted line ¼ 1% critical value.

Table 4
Regression results for aggregate consumption (these tables report only the optimal model specifications obtained using Akaike Information Criterion, AIC).

Baseline M0 Augmented M1 Augmented M2 Augmented M3 Augmented M4

Constant 2.5555nnn 2.6221nnn 2.4385nnn 2.5884nnn 2.3196nnn

(0.6070) (0.6473) (0.5973) (0.6305) (0.5802 )
ECTt  1  1.3866nnn  1.3219nnn  1.3343nnn  1.3790nnn  1.3546nnn
(0.2074) (0.2077) (0.2012) (0.2170) (0.2054)
ΔY t  1  0.3033  0.3518  0.3483  0.3081  0.3364
(0.2313) (0.2525) (0.2404) (0.2369) (0.2341 )
ΔW t  1 0.0304 0.0542 0.0469 0.0336 0.0379
(0.0575) (0.0623) (0.0587) (0.0299) (0.0678 )
oilt  0.0216nn
(0.0104)
þ  0.0051 0.0168
goilt  1
(0.0299) (0.0306 )

goilt  1  0.0345nn  0.0375nn
(0.0136) (0.0156 )

Additional model information

R2 0.4439 0.4671 0.4794 0.4441 0.4818
AIC for general model N/A 3.9974 3.9744 4.0420 4.0852
AIC for optimal model 3.8713 3.8694 3.8461 3.9117 3.8824

Notes: nnn, nn and n denote significance at the 1%, 5% and 10% levels respectively. Heteroscedasticity and autocorrelation corrected standards errors are used since the sample
size is relatively small and heteroscedasticity needs to be controlled. Standard errors are reported in parentheses. ECTt  1 is the error correction term (the residual from the
first stage regression in Eq. (5)), lagged by one period. R2 is the R-squared measure of goodness of fit. A value close to zero shows a poor fit, while a value close to one shows a
strong fit e.g. that the model describes the data very well.

Thus, the structural break is incorporated into the long-run model,
and the error-correction term that is then passed through to the
short-run equation incorporates the structural instability expli-
citly. By itself, this introduces no new statistical problems because
the procedure helps to ensure stationarity of the error correction
term, as required. The remaining part of this section presents the
results from the estimated short-run equations.
were also considered but were not significant in any lag orders so
are not reported.
The results in Table 4 are not without merit, though they do
arguably lack sufficient clarity over different types of consumption
to accurately depict the true role of oil prices. We therefore
proceed to the disaggregated consumption category results.
5.3. Regression results in categories

5.2. Short-run relationships between consumption, income, and
wealth, and the role of international oil shocks
We turn next to estimation of the short-run total consumption
equations. First, we estimate the baseline model shown in Eq. (8)
without oil shocks included and then with oil-shocks and other
factors i.e. Eq. (9). The residuals from these models, as per the
long-run equations above, are tested for structural stability, but no
additional breaks are found in these short-run equations.
From the estimation results in Table 4, we can clearly observe a
role for oil shocks in shaping household consumption in China. In
contrast to popular opinion, increasing oil prices do not have a
significant impact, whereas falling prices increase household
consumption. We also find a clear tendency for error correction,
though after the correction to the long-run equilibrium, short-run
dynamics in income and wealth have no significant impact on
changes in consumption decisions. Changes in short-term interest
We have found that aggregate consumption in Chinese house-
holds is negatively affected by international oil shocks. One natural
extension would be to try to understand how the shocks are
transmitted—in other words, whether some consumption cate-
gories are affected more than others. When households meet a
new budget constraint, such as would happen with a change in the
cost of energy, they may have to rebalance the bundle of goods
they consume. Clearly, rising oil prices may reduce household
consumption in energy-related categories. For example, one would
drive less when the price of fuel oil is higher and may therefore cut
transportation and communication spending. However, it might
not be plausible to reduce consumption of a necessity like food. It
is therefore interesting to investigate the impact of international
oil price shocks on consumptions of different categories.
Here we investigate the impact of oil shocks on the following
categories of consumption expenditure: transportation and com-
munication, food and clothing, medical expenditure, education

Please cite this article as: Zhang, D., et al., International oil shocks and household consumption in China. Energy Policy (2014), http://dx.
doi.org/10.1016/j.enpol.2014.08.034i
 D. Zhang et al. / Energy Policy ∎ (∎∎∎∎) ∎∎∎–∎∎∎ 9

Table 5
Regression results for consumption categories (these tables report only the optimal model specifications obtained using Akaike Information Criterion, AIC).

Food and clothing Medical expenditure Educ. and ent. Transportation Other living expenses

M1 M2 M1 M1 M1 M2 M1 M2
Constant 2.1964nnn 3.2879nnn 3.1717nnn 1.8782 4.7546n 5.9188nn 1.7656 -1.4865
(0.4547) (0.7328) (1.0385) (1.3803) (2.6069) (2.4509) (1.4798) (2.8461)
ECTt  1  0.6189nnn  0.5112nn  0.3150  0.0415  0.7578  0.6220  2.8868n  2.8754n
(0.1975) (0.2354) (0.7721) (1.1624) (1.1600) (1.1803) (1.6464) (1.5963)
ΔY t  1  0.0717  0.0669  0.1540 0.3289 0.0378  0.0431 0.5450 0.7012
(0.1578) (0.1375) (0.2608) (0.4517) (1.0941) (1.1163) (0.6019) (0.5252)
ΔW t  1  0.0017  0.0101  0.2158  0.0178 0.3846 0.4529  0.0743  0.0477
(0.0857) (0.0752) (0.2201) (0.2226) (0.2727) (0.3039) (0.2427) (0.3100)
ΔC t  1  0.3642nn  0.6134nnn  0.6082nnn  0.4260nn  0.4780nnn
(0.1523) (0.1058) (0.0992) (0.1582) (0.1602)
ΔC t  2  0.1834n  0.1834n  0.2311nn  0.1695n
(0.0952) (0.0839) (0.0922) (0.0986)
d
goilt  1  0.0087  0.0346  0.1425nnn
(0.0164) (0.0443) (0.0410)
d
goilt  2  0.0175  0.0429n
(0.0171) (0.0240)
d
goilt  3 0.0082  0.0527n
(0.0160) (0.0267)
d
goilt  4  0.0361nn
(0.0172)
þ
goilt  1  0.0370  0.2854nnn 0.2198
(0.0341) (0.1001) (0.1474)
þ  0.0182  0.1326
goilt  2
(0.0280) (0.2164)
þ  0.0272 0.0926
goilt  3
(0.0434) (0.0916)
þ
goilt  4  0.0955nnn 0.2261n
(0.0306) (0.1315)

goilt  1  0.0834n
(0.0422)

Additional model information

R2 0.2094 0.2428 0.1058 0.1181 0.3614 0.3794 0.3270 0.4054
AIC for general model 4.0331 4.0331 5.5786 6.8669 6.6230 6.6036 6.9137 6.9768
AIC for optimal model 3.9625 3.9193 5.5645 6.7091 6.5385 6.5516 6.7762 6.8487

Notes: nnn, nn and n denote significance at the 1%, 5% and 10% levels respectively. Heteroscedasticity and autocorrelation corrected standard errors are in parentheses. ECTt  1
is the error correction term (the residual from the first stage regression in Eq. (5)), lagged by one period.

Table 6
The reactions to oil shocks across consumption categories.

Periods after shock Price rise Price fall

þ1 Quarter Transportation expenditure ↓ Transportation expenditure ↑

þ2 Quarter Medical expenditure ↓ Medical expenditure ↑
þ3 Quarter Medical expenditure ↓ Medical expenditure ↑
þ4 Quarter Living expenditure ↑
Food and clothing expenditure ↓

and entertainment, and other living expenditure. We use the same
general short-run equation in (9), applied to each of the consump-
tion categories. Table 5 reports the regression results for each of
the categories, using M1 to denote model specifications in which
oil shocks are assumed to be symmetric and M2 for specifications
in which asymmetry is allowed.11 To control for possible auto-
correlation, we include four lags on both the dependent variable
and oil shocks. From the most general specification, an optimal
model specification is obtained using Akaike information criteria
(AIC). AIC works by selecting the model specification that best
balances the amount of information captured by a model, i.e. its
ability to explain the data that it is intended to explain, against the
size of the model used to generate that information (model
11
In these specifications, the error correction term is taken from the total
consumption model, reflecting an overall disequilibrium adjustment effect.
parsimony). A smaller model that offers the same amount of
information is favored, and reflected by smaller values of AIC,
hence the optimal model is that with the smaller AIC.
The transportation and communication category picks up the
highest and most rapid impact from oil shocks as it is the only
category to feel shocks after just one lag. M1 uses total oil returns
only, whereas M2 decomposes oil price rises and oil price falls.
Taken together, the results from these two specifications provide
reasonably clear evidence of asymmetry insofar as increasing oil
prices change consumption by a greater amount than do falling
prices. The impacts of oil shocks on the other consumption
categories, such as education and entertainment, is generally
much smaller, and their influence, when significant, takes at least
two quarters to manifest.
The consequences of an oil shock to the key consumption
categories are summarized in Table 6. Column one defines the
time period, running from the first period after the shock occurs

Please cite this article as: Zhang, D., et al., International oil shocks and household consumption in China. Energy Policy (2014), http://dx.
doi.org/10.1016/j.enpol.2014.08.034i
10 D. Zhang et al. / Energy Policy ∎ (∎∎∎∎) ∎∎∎–∎∎∎
through the fourth subsequent period (þfour quarters) when all
effects are realized. The second and third columns, respectively,
show which consumption items are affected and in which time
periods given (a) a price rise or (b) a price fall. In the period
immediately following a shock, the only consumption category
affected is transportation, irrespective of whether the shock is
positive of negative. In the second quarter, medical expenditure
decreases.12 In the third period, additional reductions in medical
expenditure imply there may have been some further health
benefits, greater even than in the previous period. It is only in
the fourth period that other consumption transfer patterns are
revealed, with expenditures on food decreasing and expenditures
on other living expenses increasing at the same time. But these
final effects manifest only when prices rise, not when prices fall.
In sum, a positive oil shock reduces transportation expenditure,
reduces medical expenditure, and causes a change in the balance
of food expenditure and consumption related to other living
expenses. In the literature review section it was generally found
that oil shocks negatively affect economic behavior, but the results
here suggest a largely positive reaction to oil shocks. To reconcile
this it should be recalled that previous literature looks at
economy-wide effects in most cases, the lens offered here is more
clearly focused on the relatively under-studied aspect of consumer
expenditure. Since it looks at a different part of the economy it
should not be expected that the same conclusions are to appear.
The results here do not so much offer a different conclusion for the
same area, rather they offer a conclusion for a different area, and
moreover the results are both plausible and intuitive.
5.4. Further discussion and policy implications
We have, to this point, illustrated that oil shocks are relevant in
household consumption choices, but in a generally asymmetric
manner. Here we consider further the implications of our results
for related policy—in particular, possible revisions to existing
domestic price regulation.
Some have argued that exposure to shocks from international
oil markets would not necessarily be a bad thing, as it may force
industry to be more responsible in cost management and create
further benefits for industrial structural reform (Lin and Mou,
2008). However, since 1993, China has been a net importer of oil,
and the pricing policies discussed above have played an important
role in ensuring stable economic growth and protection for
domestic Chinese oil producers.
The results indicate that household consumption is not
adversely affected by rising oil prices; rather, our results (consis-
tent with economic theory) imply an adjustment of household
consumption patterns among alternative goods and services in
light of the new household budget constraint. Conversely, falling
oil prices seem to stimulate overall consumption, which appears to
be a positive effect for the economy. This suggests that allowing
international oil price shocks to pass through to households (e.g.,
through international price liberalization), is not necessarily some-
thing to be afraid of.
Considering the history of price regulation discussed earlier in
the paper, it is clear that domestic prices have become increasingly
market oriented, particularly from 1998 onward. For example, the
bundle of prices pegged against was revised in 2001 and again in
2008 to reflect the true cost of importing from international oil
markets. Moreover, the window size over which oil prices are
pegged has been shortened over the years, allowing international
12
A speculative explanation for this could be that fewer cars are traveling on
the roads (the first-period effect), resulting in reduced pollutants and fewer
instances of respiratory disease and/or other ailments. However, our data provide
no way to confirm this.
Please cite this article as: Zhang, D., et al., International oil shocks and household consumption in China. Energy Policy (2014), http://dx.
doi.org/10.1016/j.enpol.2014.08.034i
oil shocks to pass through to domestic activity more quickly.
Arguably, the changes in domestic regulation have been cautiously
applied, taking steps toward oil price liberalization very carefully.
Ultimately, we consider that the path of price regulation has
been in the right direction, and that it should be maintained.
Taking a slightly more general perspective on the economy, Lin
and Mou (2008) argue that the industrial sector of the economy in
particular may benefit from oil shocks; here, we additionally
argue that household consumption may also benefit, or at least
not suffer. Since these effects imply reduced oil consumption,
transportation-related emissions should also fall. We do, however,
acknowledge the full complexity of any economic system, and that
our analysis and discussion are ultimately based on a partial
assessment of oil shocks and consumption.
6. Conclusions
In this paper, we have attempted to answer a simple question: Do
international oil price shocks pass through to domestic consumption
by the household sector in China? In this regard we demonstrate not
only that oil price shocks influence consumption, but that the nature
of these impacts differ across various different types of consumption
e.g. transport versus medical expenditure. This is in many ways
intuitive, since different consumption categories have differing levels
of connectivity to oil prices. Nonetheless empirical quantification of
such effects at an aggregate level has to date been somewhat limited
within the known literature.
Ultimately, our results point towards the conclusion that lifting
the domestic oil price policy that is currently in place in China, is a
very serious option that domestic policy makers should at the very
least entertain. To be more specific, given our results there is a
compelling argument (notwithstanding wider general equilibrium
effects that we do not model) that price regulations should be
removed since the regulation appears to offer no great benefits,
but does (i) create a costly regulation process, (ii) hinder progress
towards integration with international oil markets and (iii) dimin-
ish the co-benefits of health and environmental protection that
would result from a higher (and/or more flexible) price of oil.
Our results have their boundaries. While on the one hand there is
an argument for removing price regulation, on the other hand there
exists a counter argument which potentially over-emphasizes the
importance of the partial nature of our analysis, which concentrates
on a reasonably narrow area of the economy. While acknowledged,
this is not considered a limiting feature of the current work: though
it must be conceded that other areas of the economy, for example
the producers/firms nor the role of the government, are explicitly
characterized, the apparent gap in the extant literature motivates the
need for any empirical insights on the residential sector, partial or
otherwise. However, this line of objective criticism does give rise
to some directions for future study: who exactly are the players
impacted by oil shocks (consumers, firms, governments, oil refiners
and producers etc.); what is the balance of benefits and costs that
impact each of these players; from an economists perspective, what
are the welfare implications—who benefits more the consumer or
the producer, and is this as intended? Better understanding the
welfare implications of oil shocks would seems like a particularly
worthy direction for future study. Doing this properly would, in our
opinion, benefit most from complementary research to this study,
that takes a more careful look into the micro-level foundations of the
topics discussed here. Explorations in this direction could usefully
include analysis from micro-level firm data as well as consumer data,
seeking among other things to add deeper clarity to the substitution
mechanisms across alternative consumption categories in response
to a sudden energy price shift.
 D. Zhang et al. / Energy Policy ∎ (∎∎∎∎) ∎∎∎–∎∎∎
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