A question from Yahoo! Answers:
If oil prices rise steadily, will economical growth eventually resume despite of it?
I am trying to find out whether decline in growth is actually mechanically linked to oil price rises, or whether oil price rises merely represent a psychological shock factor whose detrimental effect wears off once consumers get used to the new reality, resulting in resumed growth. The bottom line of what I’m trying to understand is whether an oil-based economy is inevitably in decline when oil is in decline, or whether an oil-based economy is only in decline (even though oil may also be in decline) as long as anyone is frightened by this for lack of alternative scenarios.
This is pretty easy to figure out. Get time series for real oil prices and real GDP and estimate three regression models:
(1) GDPG = a + b * OIL
(2) GDPG = a + b * OILG
(3) GDPG = a + b1 * OIL + b2 * OILG
where GDPG is real GDP growth,
OIL is the real price of oil, and
OILG is the increase in the oil price compared to last year.
Then compare the R-squared and the t-statistics for the three models. If the first model is best, it is an argument in favor of the “mechanical linkage” hypothesis. If the second model is best, it is an argument in favor of the “shock factor” hypothesis. If the third model is best, it is an argument in favor of the interplay of the “mechanical linkage” and “shock factor”.