Costly Oil: Not So Scary


By Peter Coy With oil around $50 a barrel -- and briefly over $55 -- lots of people are worried about an energy-induced slowdown or even recession. Ever since the bad old 1970s, when stagflation coincided with two major oil shocks, economists have chewed over how much damage costly oil does to the economy. Now, a fresh look at the past three decades concludes that the risks of economic problems are smaller than is commonly believed.

The research was conducted by economists Robert Barsky and Lutz Kilian of the University of Michigan and published in October by the National Bureau of Economic Research (available at www.nber.org/papers/w10855.pdf).

Oil is a logical villain, for sure -- it's vital to the workings of the industrial economy, and the cost of a gallon of gasoline is probably the most closely watched price on the planet. But Barsky and Kilian say the blame on oil is overdone. Drawing on their own research and that of other economists, here's how they respond to the conventional wisdom, point by point:

High oil prices slow the economy.

Oil makes up only about 4% of output, and that's not enough to throw off the whole economy, the authors argue. Sure, some people contend that oil's role is amplified because high prices cause people to stop buying cars and other goods.

But that theory doesn't stand up to scrutiny. Drops in car sales after oil shocks are "rather small," the authors say. "No empirical support" exists for theories linking high oil prices to low productivity growth, they conclude.

Oil price shocks cause inflation.

Naturally, high oil prices cause a jump in the consumer price index. But they don't seem to set off an upward spiral. Workers swallow some of the higher costs instead of demanding higher wages to fully insulate themselves.

1970s stagflation can be explained by oil.

No again. Technically, "stagflation" consists of inflation that accelerates at a time when unemployment is high. But during the 1970s, inflation was high but not actually accelerating during periods of elevated unemployment, they say. That pattern is easily explainable without resorting to oil as a factor, write Barsky and Kilian.

OPEC is powerful.

Not really. The cartel matters, of course. But what matters more is global economic growth, which determines energy demand. Take the period of 1999 to 2000. Strong oil demand -- not newfound resolve by OPEC's leaders -- caused oil to shoot up, they say. "It seems implausible that the Mexican oil minister by his eloquence alone in 1998 managed to unify a cartel that had steadily lost influence since 1986," the authors write.

Their conclusion: Oil price shocks "may contribute to recessions without necessarily being pivotal." And "disturbances in the oil market are likely to matter less for U.S. macroeconomic performance than has commonly been thought." Coy is Economics editor for BusinessWeek in New York


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