DP6937 Oil Prices, Profits, and Recessions: An Inquiry Using Terrorism as an Instrumental Variable

Author(s): Natalie Chen , Liam Graham , Andrew Oswald

Publication Date: August 2008

Keyword(s): Energy prices , Oil shocks , Profitability , Industries

JEL(s): E3 , L6

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP6937.asp.asp

Nearly all post-war recessions were preceded by oil-price shocks, but is this because spikes in the price of oil cause economic downturns? At the heart of this question lies an identification problem: oil prices and the state of the world economy are endogenously determined. This paper uses terrorist incidents as an instrumental variable. In an international panel of industries, we show that, after correction for simultaneity bias -- though not before -- the price of oil has large negative effects upon profitability. We test for weak instruments and check sub-sample robustness. Our findings seem to lend support to the claim that oil-price spikes can be a source of recessions.