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INTERDISCIPLINARY JOURNAL OF CONTEMPORARY RESEARCH IN BUSINESS
JUNE 2011
VOL 3, NO 2
2. Previous Literature
A number of empirical researches are available on the relationship between oil price and
macroeconomic relationship. For example Hamilton (1983), Burbridge and Harrison (1984),
Gisser and Goodwin (1986), Hooker (1996), Rotemberg and Woodford (1996) found a linear
relationship between the oil price and macroeconomic activities. These studies, however,
concluded that oil price changes have different impacts on the economies overtime. The linear
relationship, however, become weekend during the eighties, because of the smaller energy
intensities, more flexible labor market and improvement in the monetary policies. Blanchard and
Gali (2007).
However with the advent of time the once symmetric linear relationship between oil price and
macroeconomic activities becomes asymmetric. To deal with the phenomena many time series
models have been included the nonlinear oil price specification. For example Mork (1989),
Hamilton (1996), Lee et al (1995), Jimenez-Rodriguez and Sanchez (2005), Lardic and Mignon
(2008) concluded that increase in oil price seems to retard the economic activities by more than
the fall in oil price stimulate it.
Mork (1989) hypothesized that oil price decrease has less impact on the economy than
the oil price increase effects. Defining the oil price increase and decrease by his own way his
results confirmed the asymmetry between oil price and economic activities. Mork defines the
increase in oil price as the positive difference between the current and lag oil price. If the
difference is negative, the positive price will be considered as zero. Similarly, the decrease in oil
price is the negative difference between the current oil price and the one period lag oil price. If
the difference is positive, it will be considered as zero.
Hamilton (1996) forms another asymmetric transformation of oil prices. He stated that
most oil price increases are the correction of earlier decline in oil prices. Thus it seems more
appropriate to compare the current oil price with that during the previous year rather than the
previous month or the previous quarter alone. Hamilton proposed that if oil price in time t is
lower than the previous year, than the increase in oil price is zero and no positive oil shock have
been occurred. Similarly, if the oil price in time t is greater than the previous year, than the
decrease in oil price is zero and no negative oil shock has been occurred.
3. Hypotheses:
This article empirically tests the following:
H 1A : The relationship between the changing oil price and industrial production in Pakistan is
symmetric.
H 2A : The fluctuations in oil prices help improving the forecast of industrial production.
4. Research Methods
4.1 Variables and Data
Monthly data on GDP is not available for Pakistan, therefore the Index of Industrial production
will be used as a proxy for the GDP. (For instance, Kumar (2005), Komain (2006), Abosedra &
Gosh (2007) and Robalo & Salvado (2008) used the Index of Industrial production as a proxy for
the GDP).
Oil price shocks are used as an explanatory variable. The oil shocks are usually defined
in terms of price fluctuations, which may be caused either by the demand or the supply side
forces. In practice it is unlikely for demand to grow rapidly enough to cause a price shock unless
it is motivated by fears of supply shortages. Historically the supply side has been primarily
responsible for the observed oil price shocks. The price shocks may be positive (a rise) or
negative (a fall) (Wakeford, 2006).We shall use the monthly Brent crude oil price as our variable
for the oil prices.
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