Trevon Logan Shows Up in the NBER Working Paper Series
The Volokh Operation Needs Quality Control

Why Are We Not Already in Recession?

Mark Thoma reads John Fernald and Bharat Trehan, who are thinking about why the recent oil price runup hasn't done more damage to the macroeconomy:

Economist's View: Why Hasn't the Jump in Oil Prices Led to a Recession? : by John Fernald and Bharat Trehan: Oil prices have increased substantially over the last several years. When oil price increases of this magnitude occurred during the 1970s, they were associated with severe recessions. Why hasn't that happened this time around?....

An intuitive way to think about the initial effects of an increase in the price of imported oil on the economy is to consider it as a tax on domestic users. In 2004, the U.S. imported almost 5 billion barrels of energy-related petroleum products, amounting to about two-thirds of domestic petroleum use.... For each $10/barrel increase in oil prices, the United States pays an effective "tax" of about $50 billion (5 billion barrels times $10), or 0.4% of GDP.

This is not the same thing as saying that GDP will fall by 0.4%.... [F]oreign oil producers... would... purchase goods from other countries... goods made in the U.S... will help support U.S. GDP....


[T]he experience of the 1970s suggests that oil shocks have a substantial effect.... Figure 1... shows that high oil prices have frequently coincided with recessions.... Hamilton (1983, 1996, 2003) has argued forcefully that the oil shocks were responsible for these recessions.... [H]e argues that... a fall in oil prices is unlikely to boost the economy in the same way that an increase can drag it down.... [O]il price increases that simply reverse previous price decreases are unlikely to have a significant effect... record an oil shock only if the... price of oil is higher than it has been over the past three years.


Figure 2 plots oil price shocks according to this recommendation. The spikes line up closely with recessions.... Moreover, the statistical evidence is not necessarily as strong as Figure 2 might suggest.... Guerrieri (2005) finds that a 50% increase in the price of oil starting in the first quarter of 2004 causes output to fall about 0.4% below what it would otherwise be in the long run (assuming that the Fed conducts policy using the well-known Taylor rule). The effects are likely to have been larger in the 1970s, when the economy was more energy-intensive....

It has also been suggested that the latest jump in oil prices has not had the usual effect on the economy because the price of oil has jumped for different reasons.... [M]uch of the run-up in oil prices in the past few years seems to reflect the endogenous response of prices to the strength of global demand. The source of this higher demand turns out to be important. If the higher prices were the result of higher U.S. demand, then there would be little reason to fear a recession. It is hard to believe that the "tax" imposed by the oil price increase would exceed the increase in income that was the cause of the higher oil demand.

But if the increase in demand originates abroad... high oil prices which reflected rapid growth in China would have the same direct impact on the U.S. as a price increase engineered by OPEC...