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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?

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oil price shocks and the economy

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 economy2
Oil Price Shocksand 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?
do oil price shocks affect economic activity
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
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
An unfavorable supply-side shock from higher oil prices

Input Scarcity (Higher Oil Prices)

GDP Growth Slows & Productivity Growth Slows

Wage Growth Slows

Price Level Rises

Interest Rate Rises

Unemployment Rate Rises

purchasing power effects
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
How sensitive is GDPto 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 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
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
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
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
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
Policy Implications

Monetary policy:

Neutrality-- balance slower growth versus higher inflation

Energy Policy:

Lowering short-term oil price spikes--role of Strategic Petroleum Reserve?