From the middle of twentieth century, due to exceptional importance of the crude oil in the supply of the world's energy demands, it has become one of the major indicators of economic activities of the world. Even after the appearance of alternate forms of energy like solar power, water and wind, the importance of crude oil as the main source of energy still cannot be denied.
This sharp increase in the world oil prices and the volatile exchange rates are generally regarded as the factors of discouraging economic growth. Particularly, the very recent highs, recorded in the world oil market bring apprehension about possible slump in the economic growth in both developed and developing countries.
A large number of researchers proposed that exchange rate volatility and oil price fluctuations have considerable consequences on real economic activities. The impact of oil price fluctuation is expected to be different between in oil exporting and in oil importing countries. An oil price increase should be considered as bad news for oil importing countries and good news for oil exporting countries, while the reverse should be expected when the oil price decreases. Through demand and supply transmission mechanism, oil prices impacts the real economic activity. The supply side effects are associated with the fact that crude oil is a basic input to production, and an increase in oil price leads to a rise in production costs ultimately that result in firms’ lower output. Oil prices changes also entail demand-side effects on investment and consumption. Consumption is also affected indirectly through its positive relation with disposable income. Moreover, oil prices have an adverse impact on investment by increasing firms’ costs. On the other hand it is generally recognized that the depreciation of exchange rate would reduce imports and expand exports, while the appreciation of exchange rate would encourage imports and discourage exports. Especially a depreciation of the exchange rate leads to income transfer to exporting countries from importing countries through a shift in the terms of trade.
Since 2003, oil prices increased continuously, even touched the peak of $137 per barrel in July 2008, but after that a declining trend was observed. After 1970s, many negative oil shocks hit the world economies. The first one was during 1973-74 caused by OPEC oil prohibition, and secondly in 1978-79 when the OPEC put restraints on its oil production. This rising trend in oil prices continued until mid 1980s, subsequently, Iraq-Iran war in early 1980s further shoot up the prices. However in 1986, when Saudi Arabia increased its crude oil production, oil price tend to decreased. In 1990s, Iraq-Kuwait war was a major factor of oil price increase but it was ended in a year because of Asian financial crisis. In 1999-2000 the OPEC again narrow its production leading to another price shock. The latest and last oil price shock was started in the year 2003 which...