The rate of interest in the UK also showed very interesting results, to an impulse shock on oil price. The middle left graph from Fig 4.4 shows the results. Initially, in the short term it is very surprising to see that an immediate after-effect of the shock is that in the following two quarters, interest rates rise. However throughout the following six to eight quarters, interest rates decrease. This is more in line with economic theory. Due to the price inelasticity of oil, the UK public are unable to reduce their consumption; therefore this could result in lower disposable income, reducing overall consumer expenditure in the economy. A method in which this can be averted is by accommodating polices. By reducing interest rates, the Bank of England would incentivise spending as credit is cheaper and therefore stimulate aggregate demand in the economy. Interest rates do not revert back to their original level throughout the 20 quarter time frame. This would suggest that an oil price shock has a lasting impact on interest rates throughout the medium and long term.
When an oil price impulse shock impacted on GDP rate, the results again seem to follow the classical business cycle theory. See lower right graph from Fig. 4.4. The short term increase in the rate GDP by 1% through the first two quarters may initially seem surprising. However this can be explained by the fact that for 17 of the 24 years of the sample period, the UK was a net oil exporter. Therefore the country would reap the benefits of an oil price shock. After two periods, the maximum point of the curve is reached. The increase is incredibly similar to that of Jiménez-Rodríguez, R. and Sánchez, M. (2004) who also observed a rise in GDP for the first two quarters then a subsequent GDP drop in the following two quarters. Throughout the medium to long term it can be observed that the GDP rate keeps falling. These results were also similar to those of Jiménez-Rodríguez, R. And Sánchez, M. (2004).They attributed this to the 'Dutch disease' which states that when a large oil price shock has occurred, this leads to a sharp appreciation of the real exchange rate of the pound. This would negatively impact GDP as net exports would decrease significantly. Like the impulse response of inflation, GDP stabilises and reverts to its original trend level after about 15 quarters, again cementing the classical business cycle theory.