The role of the trade channel in the propagation of oil supply shocks

This paper analyzes when and why idiosyncratic oil supply shocks produce large macroeconomic effects in an analytically tractable two-country general equilibrium model. We focus on a demand-driven mechanism, the trade channel, which transmits oil shocks across economies through changes in the non-oil goods terms of trade. When the trade channel is operative we have three main consequences on the transmission of oil shocks. First, the macroeconomic impact of oil shocks may be large and asymmetric across countries. Second, the magnitude of the effects is nonlinear in the size of the oil shock. Third, terms of trade movements never ensure international risk sharing after an idiosyncratic oil supply shock.