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short essays and reports on the economic issues of the day
2006 ■ Number 22

Barreling Down the Road to Recession?
Kristie M. Engemann and Michael T. Owyang
he steady rise in oil prices since 2002 has evoked concern
that, post-1981, oil price increases have had statistically no effect
about possible negative effects on the economy.1 Could
on core PCE inflation.
current energy prices push the United States into recesFinally, can we expect a recession to occur as a result of current
sion? Many economists have studied this question—in particular,
oil prices? James Hamilton believes that oil shocks affect economhow oil shocks affect both economic growth and inflation.
ic growth only when, as a result of the higher prices, consumers’
When consumer demand shifts away from energy-intensive
spending behavior changes.6 As the accompanying chart shows,
goods as a result of rising oil prices, output declines in the near
PCE growth has remained positive since the real price of oil began
term as industries’ capital and labor adjust. Timothy Bresnahan
to rise. The negative PCE growth that accompanied the previous
and Valerie Ramey studied the effect of the oil shocks of the 1970s
oil shocks has not yet occurred during the current run-up in oil
and early 1980s on the automobile industry. Specifically, they
prices. Thus, as of now, economic growth appears to be more
examined how changing demand from standard-sized vehicles
resilient to the negative effects of rising oil prices than in the
to smaller, more fuel-efficient cars affected the economy. They
1970s and early 1980s. ■
found that capacity utilization—the ratio of total cars produced
1 During the first half of August, the spot price of West Texas Intermediate,
to potential cars produced without using overtime—fell from
Cushing, was around $75 per barrel (Wall Street Journal).
above 100 percent in 1973 to around 50 percent in 1975. Similarly,
2 “Segment Shifts and Capacity Utilization in the U.S. Automobile Industry.”
capacity utilization fell from 100 percent to around 40 percent in
AEA Papers and Proceedings, May 1993, 83(2), pp. 213-18.
1982.2 Both instances followed sustained high levels of gasoline
3 “Sectoral Job Creation and Destruction Responses to Oil Price Changes.”
prices, which caused such a shift in consumer choices. Today’s
Journal of Monetary Economics, December 2001, 48(3), pp. 465-512.
4 “Are Oil Shocks Inflationary? Asymmetric and Nonlinear Specifications versus
high gas prices may do the same. The National Automobile Dealers
Changes in Regime.” Journal of Money, Credit, and Banking, May 2002, 34(2),
Association reported that year-to-date SUV sales were down 19
pp. 540-61.
percent in July compared with the same time last year.
5 Herrera, Ana Maria and Pesavento, Elena. “Oil Price Shocks, Systematic Monetary
Steven Davis and John Haltiwanger examined the effect of oil
Policy, and the ‘Great Moderation’.” Unpublished manuscript, June 2005.
price shocks on manufacturing employment between 1972 and
6 “Oil and the Macroeconomy.” Palgrave Dictionary of Economics, August 2005.
1988. They found that the sharp rise in oil prices in 1973-74 led
to an 8 percent decline in employment after two years
and total job reallocation (job destruction plus job creation) of 11 percent after four years. In the short term,
Personal Consumption Expenditures and Real Oil Price
job reallocation was higher in industries that may require
Growth Rate, %
more time to adjust labor and capital (e.g., apparel,
rubber and plastics, furniture, primary metals, and
PCE Growth Rate
transportation equipment).3
Steep increases in oil prices might also translate into
inflation of prices for other goods by increasing the cost
of production. Mark Hooker examined the effects that
oil has on personal consumption expenditure inflation,
excluding food and energy (core PCE inflation). He
found that, before 1981, a doubling of the price of oil
Real Oil Price
would lead to a 3-percentage-point increase in core PCE
inflation.4 The stance of monetary policy, however,
1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006
ultimately dictates long-run inflation. Since 1981, the
SOURCE: Recession dates (gray bars): National Bureau of Economic Research; personal consumption
expenditures (SAAR, Billions of 2000$): Bureau of Economic Analysis (growth rates are year-over-year percent
Fed has adopted a more anti-inflationary stance of
change); Real oil price: Spot Oil Price of West Texas Intermediate Crude Oil (Wall Street Journal) divided by
monetary policy, potentially lessening economic disthe seasonally adjusted consumer price index, all-items (Bureau of Labor Statistics) and multiplied by 100.
ruption from oil price changes.5 Indeed, Hooker found


Views expressed do not necessarily reflect official positions of the Federal Reserve System.