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Essay: The macroeconomic, financial and policy effects of the decrease in oil prices

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  • Published: 12 October 2015*
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The oil price has fallen by more than 50% since June 2014, as we know it was $115 a barrel.Now it is below $50.In the eight months,oil prices has fallen approximately $65 a barrel.This recession occurred because of different things which is occurring in the world.When we looked for the different reasons which is affecting oil prices.We can say the oil price partially determined by supply and demand,and also expectations.Also,we can say political and economic issues can impact of oil prices.
Firstly,we can talk about the political issues which are effecting oil prices.We should look trends of demand and supply.As we know; oil, like any other product, its cost is identified through supply and demand, when the oil market witnesses an excess in supply, its cost will be reduced. This is found in the economic downturn of the importing countries which reduces the demand because the country in downturn ability to import oil in high cost is less, this is why the demand reduces which results in the fall of oil prices. The fall in crude oil prices can be linked to three basic factors; demand,supply and the currency. On the demand side, a restrict in the IMF’s international growth prediction for 2015 in early October matched with ongoing Eurozone poor point,punctuated with very weak In German production data for August and an unattaching of long-term inflation objectives. Just as supply has actually peaked, demand for oil has been reducing. Consumption in European countries and Asia dropped in 2014, as government authorities struggled to fix financial problems. In the US, stronger gas mileage demand for automobiles and the closing of petrochemical facilities led to a decrease in demand. Perhaps the greatest aspect with a weight of on oil prices was a recession in the Chinese economies.In my opinion,economic problems in the world causes to serious effect oil consumption.
China (FXI), one of the largest consumers of oil in the world, is plagued by its own problems. China is suffering from a slowdown in its manufacturing sector. The official purchasing managers’ index, or PMI, for the Chinese manufacturing sector declined to a six-month low of 50.3 in November, as you can see in the graph above. And prospects don’t seem to have improved, with the flash PMI estimate for December coming in at 49.5.
This marks the first contraction in China’s factory output in the past seven months. The economic backdrop is dampening the demand for oil, keeping it low(Marketrealist.com).We can say, Asian countries economic situation is influencing oil prices in the world.On the supply side, the causes of supply and demand for oil can be organised mostly accountable for the drop in prices. While demand growth has chilled off due to economic weak point in countries such as China and Asia and the Eurozone, oil provide has been on the ascendant. This has tossed the balance out of strike, causing excess oil supply and an extreme drop in oil prices.
Another reason is U.S. shale boom which is resulting excess supply. The fracking revolution elicited a boom for shale-oil-rich regions. The shale boom transformation increased the production of US crude oil manifold and propelled it to multi-year highs. According to US Energy Information Administration, or EIA, estimates, US crude oil (BNO) output for the week ended December 5, 2014, increased to 9.1 million barrels a day, its highest level since 1983. The graph BELOW shows how US production has increased remarkably over the past ten years. (Marketrealist.com)
Moreover, in the 2014 U.S. dollar increased approximately by 10 percent against some major currencies.U.S dollar appreciation can create a negative effect on the price of oil as demand decrease Because if dollars increasing against the other currencies, it will reduces purchasing power of importing countries.
Impact of falling oil prices
Recently the cost of crude oil has dropped 50%. This drop in the cost of oil has an important effect in reducing transportation and other business expenses. Dropping oil expenses is great news for oil importers, such as European countries and Chinese suppliers, Indian and Japan; but, it is bad news for oil exporters, such as Kuwait, Iraq and Russia.
Also,lower oil prices impacting individual`s economies. Lower oil prices aid to reduce residing costs. Oil linked with transport costs will directly drop, leading to lower of residing and a lower rate of inflation. With passive wages, this drop in the cost of living is important for giving European customers more optional income .Furthermore, since agriculture is energy powerful, farmers are also the winners from decline oil prices.A drop in oil costs is successfully like a free tax cut. When we looked economically,the drop in oil prices could result in higher spending on other products or services and add to actual GDP. Oil is used in almost everything. Actually,we can say it is the ‘mother’ of all products. You can name it- everything that you have ever moved is relevant to oil like erasers, car, primary furnishings, outfits hook and many more customer products. Furthermore, it also impacts the working expenses of air travel and delivery companies.Theoretically, when the expenses of manufacturing drop, costs drop too. This may be approved on by means of discounted and hence smaller cost-push inflation.If we approach the more economical we can see potential growth of whole economies.Because, As I said before,falling oil prices should decrease the functional cost of a company and hence more resources are available for financial investment. They may consider this as the perfect a chance to get e.g. changing old machines with more recent and better ones, develop new industries and others. Investment is one of the elements of aggregate demand and hence aggregate demand may move rightward. In the long run, it also enhances the supply side of an economic system by increasing its prospective potential. A improve of export minus import as said before can also promote the rightward shift of aggregate demand and hence a rise in the actual GDP. This diagram shows that a fall in oil prices (and a fall in firms costs) will shift Short Run Aggregate Supply (SRAS) to the right, causing lower inflation and higher real GDP. (Some economists say a 10% fall in oil prices leads to a 0.1% increase in GDP)(Pettinger).
At the same time, there are some negative effects of falling oil prices on the economy.Specially, falling oil prices creating economic crisis in some countries.Such as; Venezuela, Nigeria, Iran and Russia will be in large financial blunder in near upcoming if oil price is not renewed to at least $100 per barrel. As I said before, large of the state income comes from oil removal and with ongoing free drop, budget/ fiscal deficit will intensify and this may cause to more problems e.g. increasing unemployment from the public industry, negative multiplier impact and hence an financial slowdown, more costly to borrow problem bonds and others.
Russia had serious affected from falling oil prices.Because,Russia is one of the largest oil producers in the world.So Russia loses about $2bn in revenues for every dollar fall in the oil price, and the World Bank has warned that Russia’s economy would shrink by at least 0.7% in 2015 if oil prices do not recover.(BBC News).We can see Russia`s big damage because of falling oil prices.
Also,Russia had already big problems after the falling oil prices.Because, Russian obtains more than 50 percent its revenue range income from oil and gas, and its economic is extremely delicate to oil price changes.When we considered from the financial side of exporters countries. Lower oil prices generally cause to an appreciation of oil importer’s foreign exchange, in particular the dollar, and to a devaluation of oil exporter’s currencies. The fall in oil price has provided to an unexpected devaluation of currencies in a number of oil exporting countries such as Russia.For this reason; the decline of the price of oil is only one of the factors behind the drop of the rouble, the Russian currency has decreased by 40 % so far this year, and 50 % since September. While managed depreciations can help oil exporters customize, they also aggravate economic issues for those companies and government authorities whose economical debts are denominated in money. And, in countries where objectives are not well attached, out of control depreciations can cause easily to very high inflation.For evidence statement which is the above, we can see inflation rate of Russia.In the April 2014 inflation rate was 6.9% but now it is 15%.This understandable chart shows us easily how to falling oil prices effect exporter’s countries economically.
Lower Prices Effect On Macroeconomic Policy
As I said before, oil is the important component of economies in the world.When we looking lower oil prices effect on the countries macroeconomic policies,we should spare two perspective which are effecting on the importing countries,and exporting countries.Firstly,we can talk about income shifts; Oil prices decreases produce changes in real income gaining oil importers and failures hurting oil exporters. The move in income from oil exporting economies with greater average savings prices to net importers with a greater tendency to spend should generally outcome in more powerful global demand over the medium term. But, the implications could vary significantly throughout countries and over time,some exporting economies may be pressured by financial constraints to modify both government investing and imports suddenly in the short term, while gains for importing countries could be dissipate and offset by higher prevention savings if confidence in recovery continues to be low.After the plunge in oil prices, governments should adjust their macroeconomic policies for adjust economies.Because, lower oil prices can have some negative and positive effect on macroeconomic policies.Now, in the importing and exporting countries we can consider monetary and fiscal policy after falling of oil prices effects.
Oil importing countries are certainly winners thanks to the reduced oil prices.Because, net importers can reduce their current account deficit. Not only would the fall in oil prices help boost,its balance of payments, would also help carry down its usually high inflation rates. Oil exporting countries are limited to be harm by less cheaper oil.we can say that Russian have been the most serious hit. Dropping oil prices have cut profits and triggered currencies to take a serious defeating. (Financetwitter.com)
In the chart which is above,we can see Russian ruble per 1 USD in 2014 and Russian government had to interfere this situation.For this reason, they had increased their interest rate from 10.5% to 17% in 16 December 2014.Also, we can see that how countries exchange rate was changing because of falling oil prices effects. As far as we are concerned,falling oil prices cause to important changes in countries macroeconomic policies as shown in Russia.
In addition,monetary and fiscal policies responses to effect of falling prices. In oil importing countries where decreasing oil prices may decrease medium term inflation objectives below focus on, central banks could react with extra monetary policy loosening, which in convert, can help development. The combination of reduced inflation and larger output implies a positive short run policy result. In oil exporting countries, however,lower oil prices might lead to contractionary fiscal policy actions, until buffers are available to secure expenses from the decline in tax earnings from the oil sector.
In a summary, The decrease in oil prices has important macroeconomic, financial and policy effects. If continual, it will support action and decrease inflationary, exterior, and fiscal stresses in oil importing nations. On the other hand, it would impact oil exporting countries negatively by weakening fiscal and exterior roles and reducing economic action.

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