Macroeconomics

Monetary policy

Volatility (finance)

Statistics

Business cycle

Energy (signal processing)

Economics

Small open economy

Dynamic stochastic general equilibrium

Mathematics

Monetary economics

Econometrics

Financial economics

Energy Policy

This paper evaluates the macroeconomic implications of energy price volatility through the lens of a dynamic stochastic general equilibrium (DSGE) model in an open economy. The model develops a small open economy in which households consume energy products and firms use energy as productivity inputs, where the country is so small that it needs to import energy, the price of which is determined abroad. Whereas positive energy price shocks cause an economic slowdown due to higher costs for consumers and firms, energy price volatility shocks generate an increase in GDP in the short-run and a reversal in the long-run. These findings are empirically supported by estimates from a Panel VAR model applied to 10 Asian economies, where energy price volatility has a positive impact on GDP in the short-run. Moreover, the paper finds that increasing demand or supply uncertainty also affect energy prices, with amplified fluctuations relative to a model that abstracts from energy. Market volatility leads households to cut consumption for precautionary savings motives, which in turn increases investment. Both energy price and uncertainty fluctuation lead to high macroeconomic volatility in the business cycle. Policy makers should encourage investment in energy security and renewable energy, such that households and firms would become less responding to fluctuations in the non-renewable energy market.

The impact of energy price uncertainty on macroeconomic variables