Developing a New Jump Based Approach to Quantifying the Consequences of Energy Price Shocks to Economic Stability

This application proposes a new jump-based framework to measure the economic stability consequences of extreme movements in global energy prices in Malaysia and 24 other emerging economies. Specifically, we intend to: (1) capture the effects of Oil and Gas price jumps on key economic indicators, (2) identify jump pass-through to stock and bond markets, and (3) capture the extent of spillover to currency stability. As Malaysia gradually moves toward a "service economy", Oil and Gas sectors still account for over 20% of her GDP and remain large contributors to government revenue and trade balance. Volatile energy prices recently, however, have stoked worries for Malaysian policymakers and corporations. The government's prime fear is failing to meet the budget deficit target. During the last budget season, former premier Datuk Seri Najib Razak lambasted the present government's fiscal calculations based on $70 oil price as absurd. Immediately, Bursa Malaysia investors responded apprehensively to uncertainty surrounding the government's coffers and to the prospect of large damages to Oil and Gas corporations’ cash flows. Meanwhile, the Ringgit is feared to further weaken in response to falling Oil prices, aggravated by policy divergence between Bank Negara and the Federal Reserve. Furthermore, analysts express concerns over supplementary spillovers to current account balance and co-dependent sectors like Palm Oil.

Keeping in mind the withdrawal of blanket Oil subsidy in 2014, global Oil price volatility now transmits through the real economy much faster. Driven by these concerns, we aim to undertake a systematic study to measure the consequences of Oil and Gas price jumps on Malaysia’s macro-economy, financial markets, and exchange rate. To ensure robust results and generate policy recommendations for fuel subsidies, import policy, regulations, and tax reforms, we propose studying 24 additional resource-dependent and structurally similar emerging economies who are likewise vulnerable to energy price shocks.