Oil Prices and Monetary Policy in Emerging Markets: Structural Shifts in Causal Linkages

ABSTRACT

This study tests the causal relationships between oil prices and monetary policy for the emerging markets (Brazil, India, Indonesia, South Africa, and Turkey). In particular, we explore the role of exchange rates, inflation, and interest rates. First, we utilize the commonly used Toda–Yamamoto causality framework and later augment the model to account for structural shifts—including gradual/smooth shifts. The empirical findings show that (i) accounting for gradual structural shifts matter for the causal linkages between oil prices and the monetary policy variables and (ii) employing a bivariate or multivariate frameworks is not important (with few exceptions) as much as controlling for structural breaks in these causal linkages.

KEY WORDS:

• causality
• emerging markets
• monetary policy
• oil prices
• structural shifts

Acknowledgments

We would like to thank the editor, Professor Ali Kutan, and two anonymous referees for their invaluable suggestions and directions. Saban Nazlioglu is a member of Outstanding Young Scientists of the Turkish Academy of Sciences (TÜBA-GEBİP 2015).

Supplemental Material

Supplemental data for this article can be accessed on the publisher’s website.

Notes

1. See, among others, Dohner (1981), Kazi (1989), Jimenez-Rodriguez and Sanchez (2004), Cashin et al. (2014), Allegret, Mignon, and Sallenave (2015).

2. These countries are also described as the “fragile five” economies, which were viewed as the most vulnerable economies to the Fed’s announcement of ending asset purchases in May 2013. The term “fragile five” was first introduced by the JP Morgan Report (2013) written by James Lord. Although the number of “fragile” economies is subject to change as economic conditions fluctuate over time, the term is still being widely used.

3. In order to save space, we omit the details of the bootstrap procedure here and refer an interested reader to Hatemi-J (2002) and Balcilar, Ozdemir, and Arslanturk (2010).

4. In order to save space based on reviewers’ suggestions, we omit the details of simulation analysis here, which are available at online supplement.

5. Even though our data set includes 192 observations, due to the relatively short time span (15 years), we opted to employ the structural shift test with one break.

6. In order to save space, we omit the details of unit root tests. An interested reader is referred to the cited articles.

Additional information

Funding

This work is a part of the project which is supported by The Scientific and Technological Research Council of Turkey (TUBITAK) under grant number 215K086.