Federal Reserve Bank of St. Louis and Poole, William, 1937 June 19- "Energy Prices and the U.S. Business Cycle." Global Interdependence Center (GIC) Abroad in Chile Conference, American Chamber of Commerce in Chile Breakfast, Santiago, Chile, March 2, 2007, https://fraser.stlouisfed.org/title/485/item/18938, accessed on March 5, 2025.

Title: Energy Prices and the U.S. Business Cycle : Global Interdependence Center (GIC) Abroad in Chile Conference, American Chamber of Commerce in Chile Breakfast, Santiago, Chile

Date: March 2, 2007
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image-container-0 Energy Prices and the U.S. Business Cycle Global Interdependence Center (GIC) Abroad in Chile Conference American Chamber of Commerce in Chile Breakfast Santiago, Chile March 2, 2007 A staple of the macroeconomics litera- ture is that energy price shocks have been an important contributor to U.S. recessions. The situation is clearly more complicated than the common macro textbook exercise of using standard dia- grams to work out the effects of an energy shock. Recent experience with a near tripling of oil prices from mid-2003 to mid-2006 without a recession suggests the need to review the con- ventional wisdom. One of my messages will be that the conventional wisdom fails to consider the fact that previous oil price shocks occurred when the U.S. economy was already suffering from substantial inflation pressures, whereas the recent run-up of oil prices has occurred in an economy with substantial overall price stability and entrenched, low inflation expectations. Before I dig into the issue of the extent of causality between oil price shocks and recessions, I want to emphasize that the views I express here are mine and do not necessarily reflect official positions of the Federal Reserve System. I thank my colleagues at the Federal Reserve Bank of St. Louis for their comments. Ed Nelson, assistant vice president, provided special assistance. I retain full responsibility for errors. THE DEBATE The historical record since 1970 provides some perspective on the relationship between oil prices and the business cycle. Figure 1 plots the U.S. benchmark oil price (the West Texas intermediate spot price), both in nominal terms (i.e., current U.S. dollars) and real terms (i.e., deflated by the CPI so as to be in constant 1982-84 dollars) since 1970. Shaded regions denote U.S. recessions, as designated by the National Bureau of Economic Research. These include the recession of 1973-75, associated with the oil price shock of 1973-74, the recessions of 1980 and 1981-82, preceded by the second oil shock in 1979, and the recession of 1990-91, also associated with a large, but more transitory, oil price increase of about 75 percent in 1990-91. There are also more drawn-out but steep oil increases in 1999-2000 and 2003-2006. The presence of the recession bars in the graph brings out what Hamilton and Herrera (2004, p. 265) observe is “a correlation between increases in oil prices and subsequent economic downturns.” In particular, recessions began in the United States within a year of the 1973, 1979, and 1990 oil price increases. There has been much debate on how much of this link between recessions and prior oil price increases should be attributed to the powerful effect of oil shocks on the economy, and how much reflects a third factor—more restrictive monetary policy imposed at roughly the same time as the oil shocks. But I would draw attention to another aspect of the relationship between the business cycle and oil prices highlighted by the figure. The United States has never had an energy price spike occur in the middle of a recession, or immediately following a recession when unem- ployment is still relatively high. This fact suggests two properties of large oil price increases that are useful to keep in mind. First, very sharp increases in oil prices that we have observed his- torically, while undoubtedly reflecting exogenous supply disruptions to some degree, also reflect 1
image-container-1 the strength of the economy at the time. Secondly, the casual association often made, based on the 1970s experience, between oil price increases and high inflation, is largely misguided because the large oil price increases of the 1970s occurred against the background of cyclical expansions that had gone too far. The 1973 and 1979 episodes did not feature inflationary spirals triggered by the oil shocks. Instead, they are characterized by preexisting, general inflationary pressures that an alternative monetary policy could have avoided. The first oil shock in 1973 occurred against a background of clear economic overheating in the United States. U.S. monetary policy was very expansionary in 1971 and 1972, leading to excessive growth of aggregate demand that, even in the presence of price controls, spilled over into rising inflation in 1973. By October 1973—that is, the month of the first oil shock, but largely before its impact could be felt in the CPI—inflation had reached 8.1 percent on a 12-month basis, a sharp rise from the 3.2 percent rate over the 12 months ending in October 1972. Annual CPI inflation subsequently rose to 11.8 percent in October 1974 and peaked at 12.2 percent in November 1974. Similarly, in the wake of several years of expanding demand, inflation rose throughout most of 1977 and 1978, well before the second oil shock, and the 12-month rate stood at 9.3 per- cent in January 1979, 2.5 percentage points above its value of January 1978. Inflation subsequently peaked at 14.6 percent in March 1980. Even the 1990 oil price spike occurred late in a long eco- nomic expansion, with annual inflation having stood above 4 percent since mid-1988. In July 1990, the 12-month CPI inflation rate was 4.8 percent, too high to correspond to price stability and not far below the July 1989 value of 5.1 per- cent. Following the oil shock that began in August 1990, inflation peaked at 6.4 percent in October 1990. ECONOMIC FLUCTUATIONS 2 0.0 10.0 20.0 30.0 40.0 50.0 60.0 70.0 80.0 0.0 10.0 20.0 30.0 40.0 50.0 60.0 $/Barrel 1982 $/Barrel Nominal Dollar Oil Price (left axis) Real Oil Price (1982-84 Dollars) (right axis) 1970 1975 1980 1985 1990 1995 2000 2005 Figure 1 Oil Prices and the Business Cycle NOTE: Shaded areas are NBER recessions.
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