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Thursday 24 Aug 2017 | 09:29 | SYDNEY
Thursday 24 Aug 2017 | 09:29 | SYDNEY

Still waiting for the oil shock



21 February 2008 08:15

On Tuesday, the oil price finally breached the US$100 a barrel mark. In fact, it had already pushed through that supposedly magic number in intra-day trading earlier this year, but this was the first time that the price per barrel closed at a triple digit number. As this nice post from Econbrowser’s James Hamilton points out, there are a number of explanations for the latest price action, ranging geographically from Venezuela and Nigeria to Saudi Arabia and Texas. 

From my perspective, however, the interesting question revolves around the so-far subdued impact of higher prices on the health of the world economy. Ever since oil prices began their ascent in 2002, economists have been wondering whether a rerun of past oil shocks was in prospect. The two big oil shocks of the 1970s – triggered by the 1973 Arab-Israeli war and the 1979 Iranian revolution – were both associated with a particularly unpleasant combination of higher inflation and recession. The more recent 1990 oil shock triggered by Iraq’s invasion of Kuwait was also correlated with these negative effects, albeit on a much smaller scale. Yet the steady run up in oil prices this century has failed to significantly disrupt global growth: we’re still waiting for the latest oil shock to materialise. So what’s different about the 2000s? 

This paper by Olivier Blanchard and Jordi Gali suggests that, as far as the developed world is concerned, lower real wage rigidity, increased monetary policy credibility, the lower share of oil in production and consumption, and plain good luck (in the sense of an absence of other negative shocks occurring at the same time) are all part of the explanation. Their paper, along with another by William Nordhaus, was reviewed in The Economist late last year.

Another widely suggested explanation for the difference between the current episode and its predecessors emphasises the difference between the impact of demand and supply shocks. Previous oil shocks have been associated with threats to supply. This time around, the driving force has been additional demand, particularly from emerging market economies like China, although clearly supply disruptions have also played a part. 

Most of these suggestions seem plausible to me, and most of them offer a degree of comfort regarding the global economy’s resilience to higher oil prices. An obvious exception to this, however, is the role that has been played by good luck, in the form of no other concurrent negative shocks for the world economy. With the fallout from the subprime crisis now rocking international financial markets, the global economic climate no longer looks as favourable. So let’s hope our good luck hasn’t run out.

Photo by Flickr user David Cushing, used under a Creative commons licence.

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