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Oil Price Shocks and the Economy
Mine K. Yücel
Federal Reserve Bank of Dallas
Forum on U.S. Energy Security
Traditional and Emerging Challenges
January 28, 2002
Resources for the Future, Washington DC
Oil Price Shocks
and the Economy
• Do oil price shocks affect economic
activity?
• Do increases and decreases in oil prices
affect the economy symmetrically?
• Is the effect real, or is it the Fed?
price
spikes
trigger U.S.
recessions
Oil Oil
price
spikes
tendtend
to betofollowed
by U.S.
recessions
Index,
Jan ' 82= 100
115
105
95
85
75
65
55
45
35
25
Source: NBER
15
49
52
55
58
61
64
67
70
73
76
79
82
85
88
91
94
97
00
Do oil price shocks affect
economic activity?
• Eight out of ten post WW2 recessions
followed by oil price shocks
• Statistical evidence links oil prices to
inflation, higher interest rates and higher
unemployment rates
• Consensus: An inverse statistical
relationship between oil price changes and
economic activity
How does an oil price change
affect the economy?
• Supply-side economic impacts
• Reductions in U.S. purchasing power
• Interaction with monetary policy
An unfavorable supply-side shock
from higher oil prices
Input Scarcity (Higher Oil Prices)
GDP Growth Slows & Productivity Growth Slows
Price Level Rises
Interest Rate Rises
Wage Growth Slows
Unemployment Rate Rises
Purchasing power effects
• Oil price increase shifts purchasing power
from oil-importing nations to oil-exporting
nations
• On net, demand for oil importer’s goods
reduced
• Lower consumption, lower GDP growth,
higher saving and lower interest rates
How sensitive is GDP
to oil price shocks?
• Empirical studies: The economy’s
sensitivity to oil price shocks has declined
in past decade
• Monetary policy can shape how oil price
shock is experienced: slower growth versus
higher inflation
Oil price shocks can magnify
errors in monetary policy
• Oil price shock => lower GDP growth,
higher inflation
• Counter-inflationary policy can aggravate
GDP losses
• Expansionary policy can aggravate
inflationary pressures
Is monetary policy the culprit?
• Early statistical evidence: no relationship
between industry activity and energy
intensity--tight monetary policy was the
culprit
• Later evidence: oil price shocks have
significant effects on economic activity
apart from monetary shocks
Is the oil price - economy
relationship symmetric?
• Rising oil prices seem to retard economic
activity more than falling oil prices
stimulate it.
• Possible explanation: more economic
adjustment costs and coordination problems
with rising oil prices
Adjustment costs
• The economy experiences some costly adjustment
to both rising and falling oil prices
– When oil prices rise, slowing economic activity is
further retarded by adjustment costs
– When oil prices fall, stimulated economic activity is
somewhat offset by adjustment costs
• We then have asymmetry: rising oil prices retard
economic activity by more than falling prices
stimulate it
The oil price - economy relationship
has grown weaker in the past decade
• Less impact on the underlying (“core”)
inflation rate
• Less negative effect on unemployment;
employment one-half as sensitive to oil
price shocks than in the 70s
Policy Implications
Monetary policy:
Neutrality-- balance slower growth versus
higher inflation
Energy Policy:
Lowering short-term oil price spikes--role of
Strategic Petroleum Reserve?