Untangling the Asymmetric Effects of Oil Price Dynamics and Disaggregated Shocks on Economic Policy Uncertainty: Evidence from India

Abstract

India’s economic policy uncertainty (EPU) is significantly affected by global commodity market fluctuations, particularly oil prices. Oil-related shocks, such as supply, demand and risk, have been shown to affect domestic, economic and financial conditions in the previous literature, but the effects of these shocks have not been fully explored in India. We set out to decompose the complex dynamics of oil price movements by applying a monthly dataset specifically for India and the high degrees in market tracking via Brent crude prices (from January 2003 to June 2024). We decompose oil price movements into three different types of shocks: supply-driven, demand-driven and risk-driven shocks and examine their effects on EPU by using an MTNARDL model with multiple thresholds. Our study finds that oil price shocks have an asymmetric and threshold-dependent effect on EPU, with long-run effects being more pronounced than short-run effects. In terms of shock components, risk-driven shocks have the strongest impact on the EPU. This research offers two significant conclusions and inferences to the body of current literature. First, the result shows that the effect of oil price shocks on EPU is intrinsically asymmetric and nonlinear, suggesting that different kinds of shocks, such as risk-driven, supply-driven, and demand-driven, transmit through different channels produces diverse policy uncertainty responses. Second, the study provides important insights for practitioners and policymakers by showing that, especially in an emerging economy like India, which is extremely susceptible to external energy shocks, the source and nature of oil price shocks must be carefully identified in order to design effective macroeconomic and stabilization policies.