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NOT AN OFFICIAL UNCTAD RECORD
The Effects of Oil
Price Volatility on the
Kenyan Economy
Eric Aligula, Wilson Wasike, and John Mutua
Infrastructure & Economic Services Division
Kenya Institute for Public Policy Research and Analysis
Presented at the
11th African Oil and Gas, Trade and Finance Conference & Exhibition
23-25 May 2007
Kenyatta International Conference Centre Nairobi, Kenya
Presentation Outline
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The Issue
The Policy Questions
Stylised Facts
Methodology
Findings
Conclusions
11th African Oil and Gas, Trade and Finance Conference & Exhibition
23-25 May 2007
Kenyatta International Conference Centre Nairobi, Kenya
Eric Aligula, Wilson Wasike, and John Mutua
Infrastructure & Economic Services Division
Kenya Institute for Public Policy Research and Analysis
2
The Issue
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Global dependence on oil to grow economies and
improve human welfare will continue for the
foreseeable future
Kenya is a net importer of oil and its derivative
products
In light of Kenya’s ambition of sustaining an average
economic growth rate of 10% annually to the year
2030, it is important to understand how oil prices and
their volatility affects the Kenyan economy
11th African Oil and Gas, Trade and Finance Conference & Exhibition
23-25 May 2007
Kenyatta International Conference Centre Nairobi, Kenya
Eric Aligula, Wilson Wasike, and John Mutua
Infrastructure & Economic Services Division
Kenya Institute for Public Policy Research and Analysis
3
The Policy Questions
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What is the nature of macro and microeconomic
impacts of oil prices and their volatility?
What are the methodological approaches for
investigating this relationships?
What should Kenya’s policy stance be in facilitating
implementation of effective mitigation measures to
control and ameliorate the negative consequences of
oil price volatility on the economy?
11th African Oil and Gas, Trade and Finance Conference & Exhibition
23-25 May 2007
Kenyatta International Conference Centre Nairobi, Kenya
Eric Aligula, Wilson Wasike, and John Mutua
Infrastructure & Economic Services Division
Kenya Institute for Public Policy Research and Analysis
4
Stylised Facts
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Oil prices affect the economy through the effects of changes in
oil price levels and oil price volatility
Both rising oil prices and oil price volatility serve to stifle
economic activity
Evidence from literature seems to suggest that small oil price
increases result in sizeable economic losses
Authors
Period Studied
Hooker
1948-1972
0.6
3-4
Hamilton (2000)
1948-1980
1.4
4
Rotemberg and
Woodford
1948-1980
2.5
5-7
11th African Oil and Gas, Trade and Finance Conference & Exhibition
23-25 May 2007
Kenyatta International Conference Centre Nairobi, Kenya
% GDP Growth
Decrease
Eric Aligula, Wilson Wasike, and John Mutua
Infrastructure & Economic Services Division
Kenya Institute for Public Policy Research and Analysis
Quarters after
initial price shock
5
Stylised Facts
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In a long period of stability, oil price shocks have a greater impact than in a
volatile environment
Ferderer (1996) explaining the asymmetry in effects in the US between 1970 –
1990 found that
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Volatility has a negative and significant impact on output growth immediately and again
eleven months later.
Oil price changes have a significant impact on output growth after about one year.
Anna Herrera (nd) looking at the US economy found that there is a substantial
time lag between the increase of crude oil and the slowdown in real GDP growth.
Typically, a decline in economic activity does not show up until four quarters after
the shock
Jones, Kaul (1996) looking at four countries found that oil price hikes had a
“significant, and (on average) detrimental effect on the stock market of each
country”.
Papapetrou (2001) looking at the Greek economy between 1989-1999 determined
that In a mid- and long-term relationship, oil price shocks account for up to 22% of
change in industrial production.
11th African Oil and Gas, Trade and Finance Conference & Exhibition
23-25 May 2007
Kenyatta International Conference Centre Nairobi, Kenya
Eric Aligula, Wilson Wasike, and John Mutua
Infrastructure & Economic Services Division
Kenya Institute for Public Policy Research and Analysis
6
Stylised Facts
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most thorough research to date has found that post-shock recessionary
movements of GDP are largely attributable to the oil price shocks, not to monetary
policy
two nonlinear and asymmetric specifications of oil price shocks have been found
that yield stable oil price-GDP relationships over the entire post-World War II
period
detailed empirical research has shown that considerable reallocation of labour
occurs after oil price shocks, amounting to as much as 11 percent of the labour
force in manufacturing, and similar extents outside manufacturing. Much of this
movement is within industry classifications that are sufficiently closely related
the best current, empirical estimates (as opposed to simulation constructions) of
the oil price-GDP elasticity are around -0.055. This is the cumulative effect on
GDP over a 2-year period of a shock in one period only, regardless whether the
price increase is sustained.
findings from studies of the effects of oil prices on the stock market parallel the
findings from more direct examination of current activity in the form of GDP.
11th African Oil and Gas, Trade and Finance Conference & Exhibition
23-25 May 2007
Kenyatta International Conference Centre Nairobi, Kenya
Eric Aligula, Wilson Wasike, and John Mutua
Infrastructure & Economic Services Division
Kenya Institute for Public Policy Research and Analysis
7
Methodological Approaches
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Input and output models which involve use of dynamic price
modelling to measure impact of price volatility on the economic
performance
Jing He (nd) applies this model on the Chinese economy and
concludes that
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the economies of oil importing developing countries would suffer most
from higher oil prices because they are more dependent on imported
oil.
In addition, energy intensive manufacturing generally accounts for a
larger share of their GDP and energy is used less efficiently. The
economic stimulus provided by higher price would be outweighed by
the depressive effects of higher prices on economic activity.
11th African Oil and Gas, Trade and Finance Conference & Exhibition
23-25 May 2007
Kenyatta International Conference Centre Nairobi, Kenya
Eric Aligula, Wilson Wasike, and John Mutua
Infrastructure & Economic Services Division
Kenya Institute for Public Policy Research and Analysis
8
Methodological Approaches
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The Granger causality method which analyses the direction of relationships
among variables.
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Erdal Atukeren (2003) analysed how an oil price shock might affect an economy in
general and the Swiss economy in particular. They determined that
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large increases in oil prices lead to a decline in Swiss GDP.
provided some evidence of an asymmetric relationship between oil price shocks and
economic performance in Switzerland, i.e., positive oil price shocks have real effects while
decreases in oil prices do not lead to a boost.
oil price increases do not affect ‘core inflation’ to any significant degree and the adverse
effects of a large oil price shock may be felt with a time lag due to differences in sectoral
responses, or because investments and consumer spending are sensitive to an uncertain
environment
Oil price shocks may affect a small open industrial economy without oil resources through
their adverse effects on the country’s export markets. We find this true for Switzerland, but
imports also shrink and lessen the overall impact on real GDP growth.
11th African Oil and Gas, Trade and Finance Conference & Exhibition
23-25 May 2007
Kenyatta International Conference Centre Nairobi, Kenya
Eric Aligula, Wilson Wasike, and John Mutua
Infrastructure & Economic Services Division
Kenya Institute for Public Policy Research and Analysis
9
Methodological Approaches
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Input and output models which involve use of dynamic price modelling to measure
impact of price volatility on the economic performance
The Computable General Equilibrium (CGE) which has been used to analyse how
price affects various sectors of the economy
Panel estimations have been used in cross country time series studies and involve
estimations of systems of equations across countries for the same variables and time
period.
The Ordinary Least Squares (OLS) approach provides a linear specification in the
model has also been used to establish the impact of price shocks on macroeconomic
variables such as the GDP.
Parametric statistical techniques specify and tests hypothesis about flexible non linear
regression specifications
The Granger causality method which analyses the direction of relationships among
variables.
The Vector Autoregressive (VAR) Model has been used to establish presence of
cointegration and relationships among macroeconomic variables in many studies on
oil price volatility
11th African Oil and Gas, Trade and Finance Conference & Exhibition
23-25 May 2007
Kenyatta International Conference Centre Nairobi, Kenya
Eric Aligula, Wilson Wasike, and John Mutua
Infrastructure & Economic Services Division
Kenya Institute for Public Policy Research and Analysis
10
Methodological Approaches
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Input and output models which involve use of dynamic price modelling to measure
impact of price volatility on the economic performance
The Computable General Equilibrium (CGE) which has been used to analyse how
price affects various sectors of the economy
Panel estimations have been used in cross country time series studies and involve
estimations of systems of equations across countries for the same variables and time
period.
The Ordinary Least Squares (OLS) approach provides a linear specification in the
model has also been used to establish the impact of price shocks on macroeconomic
variables such as the GDP.
Parametric statistical techniques specify and tests hypothesis about flexible non linear
regression specifications
The Granger causality method which analyses the direction of relationships among
variables.
The Vector Autoregressive (VAR) Model has been used to establish presence of
cointegration and relationships among macroeconomic variables in many studies on
oil price volatility
11th African Oil and Gas, Trade and Finance Conference & Exhibition
23-25 May 2007
Kenyatta International Conference Centre Nairobi, Kenya
Eric Aligula, Wilson Wasike, and John Mutua
Infrastructure & Economic Services Division
Kenya Institute for Public Policy Research and Analysis
11
Model Variables
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Crude petroleum prices
Gross domestic Product US$)
Money supply (US$)
Exchange Rate
Interest Rate
Inflation
Nairobi Stock Exchange Index
11th African Oil and Gas, Trade and Finance Conference & Exhibition
23-25 May 2007
Kenyatta International Conference Centre Nairobi, Kenya
Eric Aligula, Wilson Wasike, and John Mutua
Infrastructure & Economic Services Division
Kenya Institute for Public Policy Research and Analysis
12
Findings
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Literature shows that there is an asymmetric
relationship between oil price levels and
volatility of oil prices
The duration of an oil price increase has more
adverse effects.
However, the impact of these depends on the
nature and speed of responses within the
economy
11th African Oil and Gas, Trade and Finance Conference & Exhibition
23-25 May 2007
Kenyatta International Conference Centre Nairobi, Kenya
Eric Aligula, Wilson Wasike, and John Mutua
Infrastructure & Economic Services Division
Kenya Institute for Public Policy Research and Analysis
13
Findings
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Preliminary trend analysis was undertaken for the following variables:
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Crude petroleum prices; Gross domestic Product US$)
Money supply (US$); Exchange Rate
Interest Rate; Inflation
Nairobi Stock Exchange Index
It suggests that:
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When the economy is declining or growing slowly, the negative effects of oil price
increases are higher as in the 1990s
When it is growing robustly, the negative effects of oil price increases are subdued
as in the 60s and 70s
Results on effects between 2000 – 2006 are indeterminate but point to the fact
that recent oil price increases have not had a deleterious effect on the macro
economy
11th African Oil and Gas, Trade and Finance Conference & Exhibition
23-25 May 2007
Kenyatta International Conference Centre Nairobi, Kenya
Eric Aligula, Wilson Wasike, and John Mutua
Infrastructure & Economic Services Division
Kenya Institute for Public Policy Research and Analysis
14
Variance Decomposition of GDP
Period
S.E.
DLACRUDEP
DLEXCHRT
DLM2US$
LINFLATION
DRINTR
DLNSEINDEX
DLGDP
1.000
0.109
0.956
92.615
2.446
0.019
0.011
0.009
3.943
2.000
0.131
3.605
67.059
4.931
0.708
18.567
1.590
3.540
3.000
0.142
6.993
56.930
9.808
0.815
21.006
1.340
3.107
4.000
0.144
8.488
55.641
9.577
0.818
20.763
1.333
3.380
5.000
0.148
10.439
52.951
9.129
0.799
19.760
3.041
3.881
6.000
0.148
10.398
52.836
9.176
0.860
19.711
3.132
3.888
7.000
0.149
10.880
52.748
9.033
0.996
19.415
3.084
3.843
8.000
0.150
11.135
52.368
9.020
0.999
19.321
3.283
3.875
9.000
0.150
11.154
52.195
8.990
1.090
19.326
3.276
3.969
10.000
0.150
11.100
52.185
9.154
1.087
19.224
3.298
3.952
11th African Oil and Gas, Trade and Finance Conference & Exhibition
23-25 May 2007
Kenyatta International Conference Centre Nairobi, Kenya
Eric Aligula, Wilson Wasike, and John Mutua
Infrastructure & Economic Services Division
Kenya Institute for Public Policy Research and Analysis
15
Response of GDP
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GDP will respond positively to a shock from crude oil price
increases from 0.96% in the first period to 10.43% in the fifth
period.
From economic theory, we expect, GDP to be negatively affected
by increased crude oil prices but this is not the case from our data.
In the short run the government responses to shocks from both
endogenous and exogenous shocks through a number of fiscal
and monetary policies to cushion the economy from any adverse
effects.
The GDP will decline by 52.9% in the fifth period from a shock on
the exchange rate.
GDP has a positive shock of 9.1%, 20% in the case of money
supply and interest rates respectively.
11th African Oil and Gas, Trade and Finance Conference & Exhibition
23-25 May 2007
Kenyatta International Conference Centre Nairobi, Kenya
Eric Aligula, Wilson Wasike, and John Mutua
Infrastructure & Economic Services Division
Kenya Institute for Public Policy Research and Analysis
16
Conclusions
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There is need to maintain a consistent database to be able to have
a more robust estimation of the relationship between oil price
volatility and Kenyan economy and therefore be in a position to
design effective policy responses
Because of the nature of the available data, these findings are
preliminary because we would wish to look at these results using
monthly or quarterly data
A volatile environment weakens the effect of price level changes
since it reduces the “surprise”. Volatility creates market
uncertainties that induce companies to postpone investments. It
affects labour markets by disturbing the reallocative process
amongst sectors
11th African Oil and Gas, Trade and Finance Conference & Exhibition
23-25 May 2007
Kenyatta International Conference Centre Nairobi, Kenya
Eric Aligula, Wilson Wasike, and John Mutua
Infrastructure & Economic Services Division
Kenya Institute for Public Policy Research and Analysis
17
Conclusions
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In the interim policy measures should aim at
achieving the following in respect of the
Kenyan economy:
REDUCING THE DEPENDENCE OF THE
ECONOMY ON FOSSIL BASED OIL
 ENHANCING THE ABILITY AND CAPABILITY
OF PLAYERS IN THE ECONOMY TO SHIFT
BETWEEN FACTORS OF PRODUCTION
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11th African Oil and Gas, Trade and Finance Conference & Exhibition
23-25 May 2007
Kenyatta International Conference Centre Nairobi, Kenya
Eric Aligula, Wilson Wasike, and John Mutua
Infrastructure & Economic Services Division
Kenya Institute for Public Policy Research and Analysis
18