How Oil Price Changes Affect Inflation in an Oil-Exporting Country: Evidence from Azerbaijan

Abstract

This research study aims to explore the inflationary effects of oil price rises in the case of Azerbaijan. The study covers 1997–2021 yearly data to estimate long- and short-term impacts while considering “oil price—money supply” interactions. Autoregressive Distributed Lag Bounds testing (ARDLBT), Fully Modified Ordinary Least Squares (FMOLS), and Canonical Cointegration Regression (CCR) cointegration methods are applied simultaneously. The research findings are: (1) oil price is a significant long-term determinant of inflation in Azerbaijan, affecting overall prices directly and indirectly via the money supply; (2) the effect is statistically significant in the short-term and happens indirectly, moderated by the money supply; and (3) oil price moderates the impact of the money supply over inflation in the short-term. A major limitation of the current study is that it omits the possible moderation impact of oil prices over inflation in Azerbaijan through the resulting inflationary pressure due to oil price rises in trade-partner countries and the government’s fiscal policy. Research findings require the Central Bank to consider indirect effects of oil price changes, especially due to money supply changes, when targeting inflation and addressing policy sustainability in Azerbaijan.