Fall in Global Crude Oil Prices - Essay Example

The Global Economy Introduction In the recent decade, there has been much development in the global market. However, the global economy is facing several problems on the path of its growth. One of the major challenges that the economy faces is that of the fall in the crude oil prices that had a severe impact on the global economy (Betts and Devereux, 2000). The fall has especially affected the oil producing nations which had to face a decline in the global oil production. The developments in the global markets have led to a rise in anticipated supply of the oil prices and a fall in anticipated demand in the economy (Brown and Yucel, 2002). This sort of anticipation has led to the further fall in oil prices. Another issue that the researcher discusses is that of the fluctuating exchange rates that has in turn caused variability in interest rates. The main aim of the research is to analyse the various issues faced by the global economy and how has the economy dealt with the challenges. The research allows the researcher to study the various economic issues across the globe and the main reasons behind such issues and derive a solution to overcome these issues. Fall in Global Crude Oil prices and its implication on the global economy The crude oil prices in the economy have experienced a recent decline which had serious impacts on the economy. The global demand and supply conditions for the crude oil has led to the possible decline in crude oil prices (Fornari, et al., 2002). Prices are expected to change rapidly based on the anticipation of the researchers before the actual change. Expectation for the global oil demands have been anticipated downwards in the economy and the growth in oil prices was expected to be much lower in the economy (Jimenez-Rodriguez and Sanchez, 2005). Further, the intensity of the rise in oil prices have become half of what it was during the previous years. It had resulted in declining oil intensity and the energy efficiency of the oil prices. The researcher has found that Saudi Arabia has reduced OPEC’s oil supply and the prices were stabilized (Jimenez-Rodriguez and Sanchez, 2005). Figure 1: Fall in Crude Oil prices over the years 2014-2015 (Source: Kim and Roubini, 2000) The oil price fluctuations and the inflation rates have a positive correlation in the economy (Kim and Roubini, 2000). High inflation led to high rise in oil prices within the economy and it had an impact on the oil producing companies as there was a very low demand for crude oil. The low demand was due to rise in price for crude oil. As a result, there was excess supply of crude oil in the economy and gradually the prices fell in the later years. Rise in oil prices has led to lower output production in the United States but the fall in prices did not have any significant impact in the economy. However, the stronger monetary policy has reduced the rise in oil prices by controlling the inflation expectations and thus affecting the oil producing company’s price setting mechanism (Jimenez-Rodriguez and Sanchez, 2005). In the countries that import the oil, the falling oil prices reduce the inflation expectations in the economy. The fall in oil price affects the output of the oil importing countries as they find it more profitable to import oil at lower prices (Jimenez-Rodriguez and Sanchez, 2005). It did not have much impact on the GDP growth rate of Canada but it was indicated that the net impact of the fall in oil prices would have an overall impact on the GDP growth rate (Krichene, 2002). The fall in oil prices have proved to be very useful for the US which is the net importer of Crude oil and other petroleum products. The researchers have found that for every 10% decline in the prices of Crude oil, the GDP in the US grew by 0.1% to 0.2% (Jimenez-Rodriguez and Sanchez, 2005). The impact of the fall in oil prices was not represented in the increase in production in the economy but it had highly affected the real income growth of the economy. Lower oil prices affect the ratio of import prices to that of the export prices in the economy (Jimenez-Rodriguez and Sanchez, 2005). This in turn reduces the purchasing power due to low income and the demand for the crude oil and petroleum products. There are various reasons for the lower oil prices and the most important reason can be the low investment in the oil and gas sector. It is expected that if there is a 3% low investment in the crude oil producing sectors, there would be a 30% drop in the oil prices in those sectors (Jimenez-Rodriguez and Sanchez, 2005). Due to the financial crisis and the credit crunch in the economy, the investment in the most crucial sectors has declined leading to the fall in crude oil production in the economy. US being the net importer of the crude oil production have been highly benefited from the fall in oil prices in the economy and the crude oil consumption of US has increased with time. Around 45% of the world’s crude oil is still imported by the US (Jimenez-Rodriguez and Sanchez, 2005). The rise in the GDP growth in the US will in turn have an impact on the Canadian economy. Although the investment in the mining sector depends on the commodity prices in the international market, the activities in other sectors depends on the demand and supply mechanism. Another channel through which the Canadian GDP would be affected is that of the government spending in the economy (Jimenez-Rodriguez and Sanchez, 2005). The lower price of a commodity that is to be exported to the other nations reduces the amount of commodities to be imported from the other nations. The reduction in oil prices has an impact on the government’s balance sheets which in turn may lead to a short fall in the revenue earned within the economy. The falling income levels in the economy are represented by the fall in corporate profits and reduction in government spending. This negative impact is largely expected in the oil producing economies which would earn lower profits due to the rapid decline in oil prices. The slump in the oil prices are caused due to several factors in the economy like the economic weakness in the oil consuming countries especially China which played a key role in rising demand for crude oil (Jimenez-Rodriguez and Sanchez, 2005). Conclusion Through this research, the researcher has analysed various economic issues that take place in the Global economy. In order to have higher growth in future, the counties carry out trade within the countries. However, the fall in oil prices within the economy has a severe impact on the oil producing nations. The production of crude oil also depends on the demand and supply conditions within the economy and fall in oil prices results in a loss to the oil exporting countries who earn lower profits. Lower demands in oil also lead to reduction in crude oil production within the economy and there would be a lack of supply in crude oil and petroleum products. Introduction In this part of the research the researcher aims to analyse the fluctuations in exchange rates and the various factors that affect the exchange rate. The exchange rate fluctuations in the economy affect the trade between United States and the other countries. In case United States appreciates the dollar value the other countries find it difficult to purchase US goods and services. The research has offered a scope to analyse how interest rate differential affects exchange rates. Fluctuations in exchange rate due to variations in interest rate Due to the developments that took place in the recent decades, there was an increasing impact on the macroeconomic scenario of the world. The exchange rate acts as a tool for adapting to the changes that take place within the economy. One of the major factors that determine the exchange rate is that of the interest rate differential. Interest rates of both the countries between whom the trade is taking place acts as the short-term economic factor that affect the exchange rates (Lardic and Mignon, 2006). If a country aims to trade with another country, it keeps its interest rate high in order to bring large amount of the short-term capital flows within the economy and the currency of this country is expected to appreciate. As the currency appreciates, the goods of this country become expensive to the other trading partner. However, the country can import goods from other countries at cheaper rates. The economists have several factors to explain the interest rate fluctuations in the economy (Lardic and Mignon, 2006). The covered and the uncovered interest rate parity conditions, the rational expectations and the risk premium are needed in order to explain the fluctuations in the exchange rate in the economy (Lardic and Mignon, 2008; Brown, 2001). These fluctuations are further related to the capital flows within the trading partners. The method to pursue low interest rates in the economy would help the US monetary authorities to attain the targets related to foreign exchange rates and discourages the investors from other countries to draw securities from the US in dollars (Lardic and Mignon, 2008). Although the depreciation in the real exchange rates of dollar value during the mid of 2002 was expected to have an impact on the US trade accounts, yet the volume of goods and services produced by the US increased by around 8.1% and the imports only rose by 2.1% (Neumeyer and Perri, 2005). Researcher has studied that the depreciation in the dollar value had a very limited impact on the US balance of payments. Thus it was estimated that a depreciation of around 10% to 20% in the dollar value would lead to a one point improvement in the current deficit and the GDP ratio of US (Taylor, 2001). The slow reaction of the US trade accounts could be explained due to poor flexibility in the prices and also due to lower impact of the fluctuations in exchange rates. It was further noted that the currencies of most of the countries were tied to dollar and so the value of dollar has to depreciate according to the currency of the trading partner (Lardic and Mignon, 2006; Auerbach, 2007). The US balance of trade is expected to increase only when there is large depreciation in the dollar value. The low dollar value is likely to encourage the overseas central banks to diversify the foreign exchange reserves of those countries in order to adjust the dollar value in favour of the other currencies such that the losses related to the dollar based assets are reduced. According to a researcher, if there is a fall in dollar value by 22.8% it would cost China around 5.3% of its GDP (Lardic and Mignon, 2006). However, the policy followed by the non-US Central Banks is expected to pose major problems to the United States. United States faces the external deficits which it has to finance by raising the interest rates such that the private investors would take the Central Banks under their control by purchasing assets at a depreciating currency (Lardic and Mignon, 2006). The rise in the US interest rates would lead to the recessionary effects connected to the financial crisis. Further, if the price of goods imported by US rises, there would be a fall in dollar value which in turn leads to reduction in purchasing power of Americans. However, in the later years Japan also practiced the devaluation of Yen in order to export goods and services. The policy was followed by Japan to purchase goods in Japanese currency at low interest rates and then it invests the funds in high value yielding assets in Euros and in Dollars. Maintaining very low interest rates have made Japanese Central Banks to conduct trade with other countries and further lower the value of Yen (Lardic and Mignon, 2006). Nonetheless, the European economy has lost its price competitiveness due to the overvaluation of Euro and the situation has threatened the trade performance of EU and therefore the growth is further affected (Lardic and Mignon, 2006). The fluctuation in the value of Euro has a severe impact on the Euro Zone and further affects the trade among European countries. Likewise, the other countries like Russia and Switzerland had controlled their own currencies in order to undertake trade policies within the economy (Lardic and Mignon, 2006). Exchange rate fluctuations have further affected the tax liability of the economy as a whole. In most cases the countries would be in advantageous position if they consider foreign income tax as the tax credit (Allayannis and Ofek, 2001; Auerbach, 2007). Other taxes like the property taxes are not suitable as tax credit. However the reduction in tax liability in the economy would be beneficial for some of the companies in different countries such that they can carry out the exchange of goods and services. In case the US income tax is imposed on US dollars it poses problems to all tax payers in the economy because US dollars are considered as the functional currency of tax payers in the economy (Ize and Yeyati, 2003). The employees within the corporate houses face challenges of paying high income taxes on their revenues in case their income is in terms of US dollars (McKinnon, 2001). However the redemption of foreign tax would be possible if there is any change in foreign tax liability in the economy that affects the US foreign tax credit. Conclusion To conclude it can be said that fluctuations in the dollar value have affected the trade and development of the countries. If US appreciated its dollar value, it would be difficult for the other countries to import goods from the US as the goods would be very expensive. The interest rate however acts as a short term economic factor that affects the exchange rates of the trading partners. Based on the level of interest rates the country appreciates or depreciates its exchange rate which in turn affects the trade within countries. Reference List Allayannis, G. and Ofek, E., 2001. 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