Causes and Consequences of Oil Price Shocks on the UK Economy

In this paper, we assess the impact of oil price fluctuations on the UK
economy. We use an empirical strategy which allows us to decompose oil
price changes from the underlying source of the shock. Our results show
that, since the mid-1970s, oil price movements have been mainly associated
with shocks to oil demand rather than oil supply. We also find that the
consequences of oil price changes on UK macroeconomic aggregates depend
on the different types of oil shocks. While increases in global real economic
activity do not depress the UK economy in the short run, shortfalls in
crude oil supply cause an immediate fall in GDP growth. In addition, since
monetary policy depends on the nature of the shock hitting the oil market,
domestic inflation increases following a rise in the real oil price. Finally,
our results also show that in response to oil price increases, the government
deficit decreases.