The effect of oil price shocks on global economy has been a
great concern since 1970s and has instigated a great deal of research
investigating macroeconomic consequences of oil price fluctuations.
Later on, the instability in the Middle East and recent oil price hike
confirmed the enduring significance of the issue. Though a voluminous
body of literature has evolved examining the bearings of oil prices for
internal sectors of economies [to name a few, e.g., Barsky and Kilian
(2004); Kilian (2008a,b); Hamilton (2008)], the studies analysing the
external sector response to oil price shocks are very few [see, e.g.
Kilian, et al. (2007)]. The determination of current account and
exchange rate—the two major indicators of external sector—has been
studied widely in theoretical and empirical literature but mostly the
discussion of the two variables largely remained separate [Lee and Chinn
(1998)]. Similarly, investigation of simultaneous response of these two
variables to an oil price shock remained relatively less ventured avenue
of research. Initial work done on the relationship between current
account and oil price could not ascertain conclusive link between these
two variables.1 Recent work on the issue revealed the diversity of
responses of current account of different countries to an oil price
shock. For instance, oil price increase deteriorates current account
balance of developing countries [OECD (2004); Rebucci and Spatafora
(2006); Killian, et al. (2007)] but may improve it if the country
happens to be a net oil-exporter. This implies that the relationship
depends on the number of factors among which oil dependency of country,
oil-intensity of production process2 and responses of non-oil trade
balance3 and sources of oil price fluctuations4are of particular
significance.
Oil Price Shocks and Conflict Escalation: Onshore versus Offshore
