Role and Impact of Energy in the Business Cycle

Given the fundamental role of energy in the economy, the macroeconomic liter- ature contains a large body of work on the impact of oil/energy on the business cycle, with much of the attention focusing on energy supply shocks, mostly modeled as exogenous oil/energy price increases. And yet, the oil price hikes pre-2008 suggest that other shocks to the energy market may be the source of such instance of price disturbances, so that their eects on the economy are no longer predicted by exogenous energy supply shocks. In such scenario, it is no longer valid to treat energy price disturbances as exogenous shocks to an economic model that seeks to study the impact of energy on the business cycle. The empirical works of Kilian (2008, 2009) arm this point, showing that it is imperative not to view all oil/energy price increases as alike in terms of their impact on the economy, and that the underlying causes of the increases matter. There is thus a need to have a theoretical framework that helps disentangle the various sources of shocks to the energy market and understand the distinct mechanisms that may be at play.

This dissertation advances the study of the role of energy in the business cycle. In terms of theoretical modeling it extends the usual RBC framework with oil/energy to include an endogenous energy sector with convex energy production costs, as well as the explicit production and consumption of energy- dependent and non-energy- dependent goods. The former extension enables the investigation of demand shocks to the energy market, by producing low price elasticity of energy supply, as observed empirically, and meaningful en- ergy price responses to changing energy demand. The latter establishes the theoretical link between the degree of energy dependence of a good and energy price disturbances. These features form the theoretical backbone for the anal- yses in all three chapters in this dissertation. Chapter 1 uses a closed-economy RBC model to demonstrate the distinct impacts of dierent energy supply and demand shocks on the macroeconomy, highlighting the dierent channels through which the shocks are transmitted. Chapter 2 extends this one-country framework to a two-country model with trade to study the general equilibrium eects of energy price shocks on external balances of energy-exporting and energy-importing countries. Finally chapter 3 revisits the question of the conduct of monetary policy in the events of these supply and demand shocks, prescribing the desirable monetary responses to minimize the shocks' impact and comparing the obtained results with those from previous literature.