Revisiting the Dynamic Effects of Oil Price Shock on Small Developing Economies

This paper examines the dynamic effects of oil price shocks in addition to the aggregate supply and aggregate demand shocks on macroeconomic fluctuations in four sample economies: Indonesia, Malaysia, Pakistan and Thailand using structural VARs. The study reveals that oil-importing countries, such as Pakistan and Thailand, oil price shocks affect negatively output growth and affect positively inflation. On the other hand, our results show that oil price shocks have positive effects on both output and inflation in oil-exporting countries Indonesia and Malaysia. This implies that an oil price increase also has an adverse effect in oil-exporting economies by raising the inflation. The findings suggest that an anti-inflationary policy would be beneficial to reduce aggregate spending to control inflation in oil-exporting countries. The empirical evidence also suggests that it is less likely that oil price shocks have a substantial impact on macroeconomic fluctuation in sample countries. In Malaysia, Pakistan and Thailand, the supply (productivity) and nominal demand (inflationary) shocks are the main sources of fluctuation in output and domestic price level, respectively. Interestingly in Indonesia, nominal demand and supply shocks are the key contributor of the variation in output and inflation respectively. This leads to simple policy recommendations that the contribution of a suitable fiscal adjustment to support production sector in Indonesia. For South Asian countries, the recession experienced in the 1998 was largely caused by demand and supply shocks. However, oil price had little effect on the recession of 2008-09.