Oil and the Macroeconomy Since the 1970s

TLDR

Oil price increases have been blamed for recessions, high inflation, reduced productivity, and slower growth, and are still thought to explain the 1970s US stagflation. The authors aim to review and critique the arguments that assign a central role to oil price shocks in macroeconomic fluctuations. They analyze conceptual difficulties, challenge the exogeneity of major oil price movements, and argue that macroeconomic variables can drive oil prices rather than the reverse. The study finds that oil price shocks do not uniquely explain US stagflation.

Abstract

Increases in oil prices have been held responsible for recessions, periods of excessive inflation, reduced productivity and lower economic growth. In this paper, we review the arguments supporting such views. First, we highlight some of the conceptual difficulties in assigning a central role to oil price shocks in explaining macroeconomic fluctuations, and we trace how the arguments of proponents of the oil view have evolved in response to these difficulties. Second, we challenge the notion that at least the major oil price movements can be viewed as exogenous with respect to the US macroeconomy. We examine critically the evidence that has led many economists to ascribe a central role to exogenous political events in modeling the oil market, and we provide arguments in favor of ‘reverse causality’ from macroeconomic variables to oil prices. Third, although none of the more recent oil price shocks has been associated with stagflation in the US economy, a major reason for the continued popularity of the oil shock hypothesis has been the perception that only oil price shocks are able to explain the US stagflation of the 1970s. We show that this is not the case.