Oil shocks and unexpected economic policy uncertainty: evidence from wavelet nonparametric quantile causality

Abstract

The persistent volatility in global oil markets and the unpredictability of economic policy have intensified concerns over their interconnected impacts on macroeconomic stability. However, existing studies often overlook this relationship’s asymmetric and frequency-dependent nature. This study addresses this gap by investigating the causal nexus between Unexpected Economic Policy Uncertainty (UEPU) and four disaggregated oil shocks, Oil Supply Shocks (OSS), Economic Activity Shocks (EAS), Oil Consumption Demand Shocks (OCDS), and Oil Inventory Demand Shocks (OIDS), from January 1985 to August 2024. A novel contribution lies in constructing a UEPU index using an AR (1)-GARCH (1,1) model on traditional EPU data to better capture unforeseen policy dynamics. Utilizing the Wavelet Nonparametric Quantile Causality (WNQC) approach, the study reveals substantial bidirectional causality, varying across timescales and quantiles. UEPU exerts a stronger and more consistent influence on OSS and EAS in the short- to medium-term, while its effects on OCDS and OIDS are episodic and concentrated at extreme quantiles. Conversely, feedback effects from oil shocks to UEPU are weaker and context-specific. These findings underscore the need for transparent and stable policy frameworks, institutional buffers, and coordinated energy strategies to manage uncertainty and prevent destabilizing feedback between oil shocks and policy volatility.