Oil prices shocks have a stagflationary effect on the macroeconomy of an oil importing country: they slow down the rate of growth (and may even reduce the level of output \u2013 i.e. cause a recession) and they lead to an increase in the price level and potentially an increase in the inflation rate. An oil price hike acts like a tax on consumption and, for a net oil importer like the United States, the benefits of the tax go to major oil producers rather than the U.S. government.
\ue000- The shock\u2019s persistence
\ue000- The dependency of the economy on oil and energy
\ue000- The policy response of monetary and fiscal authorities
The price of oil has fluctuated widely over the past 50 years. Before 1973, prices were effectively dictated by a buyers\u2019 cartel of major global oil companies (the so-called \u2018Seven Sisters\u2019). The first \u2018oil shock\u2019 occurred when members of the Organization of Petroleum Exporting Countries (OPEC), acting partly in response to the United States\u2019 support for Israel in the 1973 Yom Kippur war, agreed to control oil supplies and raised prices fourfold.
Oil prices stabilized in the late 1970s, before rising to a new peak with the outbreak of war between Iraq and Iran in 1981. The peak was short-lived and prices generally declined in real terms over the next twenty years, with the exception of a brief upturn associated with the 1991 Gulf War. By 1999, the oil price fell as low as $13/barrel, equivalent in real terms to the price prevailing before 1973.
Prices began to recover in 2000, initially responding to cutbacks in OPEC output and then to strong global demand, particularly from the United States and China. The price of $60/barrel currently prevailing, and expected, on the basis of futures prices, to persist
The oil shocks of 1973, 1981 and 1991 all coincided with recessions in the United States. In these circumstances, it is not surprising that the recent increase in the price of oil should raise concerns about the possibility of a new recession In reality, however, the significance of the relationship between oil prices and macroeconomic activity has been overstated.
The responsiveness of oil prices to macroeconomic shocks is clear in the case of the original 1973 oil shock. An inflationary upsurge was well under way by the time OPEC oil ministers met in October 1973. Wage and price controls had been imposed in the United States in 1971, but had broken down by early 1973\u2014the oil shock merely administered the coup de grace, leading to the final abandonment of controls. Prices of all kinds of commodities were skyrocketing, and monetary policy was being tightened in response, making a decline into recession inevitable. Because of the cartelized nature of the oil market, oil prices responded with a lag, just as the world economy was beginning its downturn.
on October 18, 1973. the day before the oil embargo began. Initially the ten-year yield actually declined, reaching a low of 6.67 percent two months later. Over subsequent months, bond markets gradually sold off as the oil price hike began to be viewed as permanent, with serious inflationary consequences. But the bond market continued to trade in an orderly fashion. There were no sudden, sharp yield spikes. By March 18.
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