Objectives: We estimate the effects of demand and supply shocks in the global crude oil market on several measures of oil exporters’ and oil importers’ external balance (including the oil trade balance, the non-oil trade balance, the current account, capital gains, and changes in net foreign assets (NFA)) during 1975­–2006. We also examine the changing importance of these shocks over time by means of historical decompositions and variance decompositions.

Data / Methods: The analysis departs from the existing literature in several dimensions. (i) We avoid some of the methodological drawbacks of earlier studies by exploiting recent advances in the measurement of oil shocks. We both control for reverse causality from global macroeconomic aggregates to the real price of oil, and differentiate between different sources of variation in the real oil price, using an SVAR framework. The analysis illustrates the importance of distinguishing between oil-price changes driven by crude oil supply shocks, oil-market specific demand shocks, and innovations to the demand for all industrial commodities driven by the global business cycle.

(ii) Previous studies generally focused on the trade balance and current account. This paper differentiates between the effects of oil shocks on the oil- and the non-oil trade balance, highlighting the role of the latter in offsetting oil trade deficits. We also consider the effects of oil shocks on NFA valuations. The existence of valuation effects in general has been documented for the U.S. and other countries. This paper addresses the complementary question of whether there exist systematic valuation effects in response to oil demand and oil supply shocks that help financially integrated economies cope with oil trade imbalances.

(iii) Previous studies focused on selected oil-importing advanced economies, leaving many questions unanswered. E.g., how do oil exporters respond to oil shocks? This paper takes a wider perspective. In addition to Japan, the Euro area and the U.S., we consider broad aggregates of oil-importing and oil-exporting economies. This allows us to interpret our empirical results in light of recent theoretical advances (a) in modeling oil demand and oil supply shocks in the two-country DSGE framework, and (b) in modeling valuation effects in incomplete markets.

Results: (i) The effect of oil demand and supply shocks on the merchandise trade balance and the current account, which depending on the source of the shock can be large, depends critically on the response of the non-oil trade balance. Our estimates provide a benchmark for models of the international transmission of these shocks under incomplete markets. (ii) There exist potentially large and systematic valuation effects in response to these shocks. Valuation effects overall tends to cushion the effect of oil demand and supply shocks on the NFA positions of oil exporters and oil importers. (iii) We quantify the overall importance of oil-market specific demand and supply shocks for external balances. For example, these shocks jointly account for about half of the variation in oil exporters’ changes in NFA, whereas demand shocks associated with the global business cycle account for an additional one-third.