The dynamics of oil prices, uncertainty measures and unemployment: a time and frequency approach

Abstract

PurposeThis study investigates the nexus between the returns on oil prices (OP) and unemployment (UR) while taking into account the influences of two of the most representative measures of uncertainty, the Baker et al. (2016) and Caldara and Iacovello (2021) indexes of economic policy uncertainty (EP) and geopolitical risks (GP), in the relationship.Design/methodology/approachThe authors use data on the US, Canada, France, Italy, Germany and Japan from January 2000 to February 2022 and the UK from January 2000 to December 2021. The authors then apply the continuous wavelet transform (CWT), wavelet coherence (WC), partial wavelet coherence (PWC) and multiple wavelet coherence (MWC) to examine the returns within a time and frequency framework.FindingsThe CWT tracks the movement and evolution of individual return series with evidence of high variances and heterogenous tendencies across frequencies that also align with critical events such as the GFC and COVID-19 pandemic. The WC reveals the presence of a bidirectional relationship between OP and UR across economies, showing that the two variables affect each other. The authors’ findings establish the predictive influence of oil price on unemployment in line with theory and also show that the variation in UR can impact the economy and alter the dynamics of OP. The authors employ the PWC and MWC to capture the impact of uncertainty indexes in the co-movement of oil price and unemployment in line with the theory of “investment under uncertainty”. Taking into account the common effects of EP and GP, PWC finds that uncertainty measures significantly drive the co-movement of oil prices and unemployment. This result is robust when the authors control for the influence of economic activity (proxied by the GDP) in the co-movement. Furthermore, the MWC reveals the combined intensity, strength and significance of both oil prices and the uncertainty measures in predicting unemployment across countries.Originality/valueThis study investigates the relationship between oil prices, uncertainty measures and unemployment under a time and frequency approach.HighlightsWavelet approaches are used to examine the relationship between oil prices and unemployment in the G7.We account for uncertainty measures in the dynamics of oil prices and unemployment.We observe a bidirectional relationship between oil prices and unemployment.Uncertainty measures significantly drive oil prices and unemployment co-movement.Both oil prices and uncertainty measures significantly drive unemployment.