Energy prices and economic activity in the US

At least since the oil price shocks and the subsequent recessions of the 1970s, economists have been interested in the relationship between energy prices and economic activity. Economic theory and empirical literature over the last 40 years have suggested that this relationship has evolved over time. Controversy has arisen over the direction of causality, and even whether it is bidirectional or a decoupled relationship. The findings over the years have been equivocal. This thesis therefore strives to shed new light on the energy price–economic activity nexus through a time-varying Granger causality test, which is known to outperform other methods and to therefore provide a more credible conclusion. The results of this study show that the crude oil price and industrial production have a bidirectional causal relationship between August 1998 and August 2005, and from November 2014 to September 2016. Both periods are initiated by innovations in economic activity. A causality running from economic activity to oil price is also detected from October 2008 to April 2010. These results confirm the literature findings that oil price is predominantly demand-driven post-1985. Since evidence in the literature for natural gas and coal prices is very limited, the finding of unidirectional causality running from industrial production to prices for natural gas in the late 80’s, 90’s and mid-2017, as well as a causality running in the opposite direction for coal in 2009 and more recently, advances our understanding of the overall energy price–economy nexus. In light of these findings, policy implications to promote alternative energy sources and extend energy price insurance markets are discussed.