Investigating the Impact of Oil Price Volatility on the Nexus between the Macroeconomy and the Banking System in Iraq: An MSH-VAR Approach

This study investigates how oil-price volatility shapes the linkages between Iraq’s macroeconomic conditions and the banking sector within a Markov-Switching Heteroskedastic VAR (MSH-VAR) framework. Using quarterly data for ۲۰۰۴–۲۰۲۲, it assesses the effects of global oil-price fluctuations on the Banking Fragility Index (BFI), real GDP, and the exchange rate. The regime-switching structure captures asymmetric and state-contingent responses, separating relatively stable phases from more turbulent periods with higher volatility and persistence. The results indicate that oil-price shocks have a strong and statistically significant effect on real GDP, while their immediate impacts on banking fragility and the exchange rate are relatively limited. In the stable regime, Iraq’s economy exhibits a greater capacity to absorb positive oil price shocks, leading to smoother and more persistent adjustments in macroeconomic indicators. Conversely, in the unstable regime, negative oil shocks generate asymmetric and pronounced adverse effects, including contractions in GDP, increased banking fragility, and heightened exchange rate volatility. The impulse response functions corroborate these regime-specific patterns and highlight the vulnerability of Iraq’s oil-dependent economy to external shocks. These findings underscore the importance of strengthening banking supervision, establishing a financial stabilization fund, improving monetary-fiscal coordination, and promoting economic diversification to enhance resilience and long-term macro-financial stability.

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Keywords: Oil price volatility ، Iraqi banking system ، banking fragility ، macroeconomy ، MSH-VAR model