Oil Prices and the Economy, Then and Now

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THE STUDY MAY 6, 2011

Oil Prices and the Economy, Then and Now

After sinking on Thursday, oil prices recovered Friday, climbing back over $100 a barrel. A stronger-than-predicted jobs report fueled expectations of a stronger economy, and more demand for oil. Still, high prices on the exchanges mean high gas prices, which have been something of a tradition every summer since the OPEC embargo in 1973. But are high prices at the pump as economically damaging as they used to be?

No, according to economists at MIT and the University of Rome. In a 2009 paper, Oliver Olivier Blanchard and Marianna Riggi--guess which one was studying in Rome--noted that in the 1970s, large increases in oil prices led to "sharp" decreases in output and large inflation increases. However, since 2000, though price increases have become even larger, oil's effects on output and inflation have shrunk. Blanchard and Riggi constructed a model of the effect of oil shocks on the economy, and found two factors: vanishing wage indexation, and an improvement in the credibility of monetary policy. The authors were unable to determine which of the two factors was more important, but at the very least we now know that bell bottoms weren't the only bad thing about the 70s.

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posted in: the study, marianna riggi, oliver blanchard, organization of petroleum-exporting countries

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