Oil price shocks and producer prices in Taiwan: an application of non-linear error-correction models

Abstract

This study estimated the short-term and long-term pass-through effects of oil prices on inflation in Taiwan from 1981M1-2011M5, employing the producer price general index and various basic sub-indices for evaluation. The empirical results show that oil prices have long-term and short-term pass-through effects on Taiwan’s producer price indices. Moreover, producer prices have significant non-linear error-correction relationships with the oil price, output and wages, suggesting asymmetric and time-variant properties of error correction. When the deviation of price in the equilibrium is greater, the error-correction adjustment will be faster. Our findings could therefore enable the monetary authorities and manufacturers to formulate a more effective policy from the oil price shocks.

Keywords:

• oil prices
• PPI inflation
• pass-through
• non-linear error correction
• augmented Phillips curve

JEL Classifications:

• E31
• F30
• Q43

Notes

1. Kilian (2009) classified the source of the widely discussed substantial oil price shocks on supply (such as the 1973 and 1979 Middle East oil crises and the sudden rise in oil prices after the 1990 Persian Gulf War) and demand (such as the record high oil price spikes between 2003 and 2008 and the rapid increase in oil prices caused by the 2009 global financial crisis that continues even now).

2. Some empirical studies focusing on emerging markets support the view that oil prices are significantly correlated to the economic activities (Balaz and Londarev 2006; Balaz and Londarev 2006; Cologni and Manera 2008; Gronwald 2008; Kilian 2008).

3. Bernanke, Gertler, and Watson (1997) indicated that the Fed underestimated the stagflation threat in the oil shocks in the 1970s and adopted an overly high interest rate policy, which is thought to have exacerbated the recession.