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If oil price changes reflect demand shocks, then an oil price decline, say, would suggest a
slowdown in global economic activity. Alternatively, if the oil prices are driven by supply
shocks, then the drop in prices might indicate a forthcoming boost in spending as firms
and households benefit from lower energy costs. In this paper, I use correlations of
weekly oil price changes with a broad array of financial variables to decompose oil price
changes in components due to global demand and those due to global oil supply.
Quarterly aggregates of these two weekly oil price shocks are then used as proxy
variables to identify the impact of latent oil market shocks in a quarterly
macro-economic VAR model of the U.S. economy. This analysis shows that supply-driven
oil market shocks can potentially impact U.S. economic activity in a more significant
manner than demand-driven oil market shocks.