BERJ 4(1)13 Article 3 pp.43-57 - Business and Economics...

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Business and Economics Research Journal Volume 4 Number 1 2013 pp. 43-57 ISSN: 1309-2448 The Effect of Oil Prices on Unemployment: Evidence from Pakistan Fawad Ahmad a a Lecturer (Finance), Management Sciences Department, Iqra National University, Peshawar, Pakistan, [email protected] Abstract : A developing country like Pakistan is heavily dependent on the oil as inputs for almost every industrial sector therefore increase in oil prices, increases inputs cost, consequently increasing production costs and unemployment rate. Existing literature has mostly focused on the relationship between unemployment and oil prices of developed countries, the current study used the data from developing country Pakistan to investigate the relationship between oil prices and unemployment. The current study used monthly data from the period 1991:01 2010:12, making 238 observations of each variable for analysis and employed Toda Yamamoto causality test. The results of current study suggested the significant effect of oil prices on unemployment but found no significant association between real interest rate and unemployment, thus findings of current study are partially consistent with the efficiency wage model. Furthermore, results suggest that real oil prices cause significant changes in the real interest rate in Pakistan. It can be concluded from the results that oil prices can be used in long run to improve the forecasting of unemployment and real interest rate. Keywords : Oil prices, Interest rate, Unemployment, Efficiency Wage Model, Toda-Yamamoto JEL Classification : C32, E24, Q43 1. Introduction The existing literature has suggested various transmission channels for the possible impact of oil price shocks on economic activity (Brown and Yucel, 2002). The rising oil prices leads to the increase in the prices of petroleum products, energy bills (consumers, industries, government) and production costs, consequently increasing the unit production cost and lowering the productivity level. The decline in productivity directly affects the unemployment rate, real wage rate, product selling price, consumption level, investments, interest rate and inflation rate (Loungani, 1986). This association of oil prices with productivity and unemployment is not only valid for the manufacturing economies but also for the agriculture dependent economies (Uri, 1995). As Pakistan is agricultural country thus this association may also hold for the Pakistan economy. Unemployment is one of the important macroeconomic issues that all governments and economies face. It has both social and economic implications for all economies; therefore governments try to adopt policies that help in increasing employment rate. Furthermore, policy makers study various factors and phenomena that may have effect on increasing unemployment and come up with new suggestions and polices to improve employment rate.
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