The Atlanta Fed's macroblog provides commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues.

Authors for macroblog are Dave Altig, John Robertson, and other Atlanta Fed economists and researchers.

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April 08, 2005

Energy Prices: Not The 1970s Redux (?)

Over at Bloomberg, Caroline Baum makes mostly good sense:

Energy is a hot topic, as anyone who's been even semi-conscious for the past year knows. Too bad it's so widely misunderstood.

Take, for instance, the "expert'' (on what, it's not clear) on TV yesterday morning who said "you either get tightening from the Fed or (from) oil markets.''...

Oil-producing countries, OPEC and non-OPEC alike, manage supply. When OPEC curtailed oil exports to the West in the 1970's, the result was sharply higher oil prices and sharply lower economic growth. 

Such an outcome, known as a supply shock, is represented by an inward shift in the supply curve.

That isn't the situation today, where surging global demand -- an outward shift in the demand curve -- raised the price of U.S. light sweet crude to a record $58.28 this week.

While we can quibble over whether policy makers are trying to slow economic growth or just ease up on the gas, demand is their game, not supply. 

Our TV expert assumes that a rise in the price of oil, no matter how induced, is the equivalent of higher interest rates...

Yesterday's Wall Street Journal didn't do much better in a front-page article on the Saudi offer to boost output.

First we are told that demand is growing in the U.S. in spite of high gas prices. Demand remains strong in China, India and Asia's booming economies.                        

The Fed plays in the adjacent ballpark. The central bank influences aggregate demand for goods and services in the economy by adjusting the overnight federal funds rate.       

The conclusion? "Higher prices are slowing the world economy,'' the article said, before "supporting'' the conclusion with... forecasts of stronger demand. Huh?   

I'm going to disagree a bit with the implication there.  From the perspective of an oil-importing country, oil price increases represent, in part, an external shock to the cost of production.  Such shocks do indeed have some of the flavor of a supply shock.

Here's a picture I find interesting.



As we entered the latest series of oil shocks in 2002, energy efficiency -- measured by the quantity of energy usage per inflation-adjusted dollar of GDP -- had fallen significantly from 1970s levels.  Energy dependence -- measured by the gap between consumption and production per unit of GDP -- has, on the other hand, remained remarkably constant.  That says to me we should not be so quick to dismiss analogies with the situation in the 1970s.

That said, I can't say I disagree with Ms. Baum's policy conclusion.

Consider this: If OPEC stopped pumping oil tomorrow, and prices soared to $105 a barrel, does that mean the Fed should lower the funds rate to 1 percent, increase the money supply and put its imprimatur on what would surely be the next stagflation?      

Hardly. That would be the outcome if the Fed eased in the face of supply constraints.

How about looser monetary policy in the face of demand- driven higher oil prices? That wouldn't make much sense either, since cutting the funds rate would stimulate already strong demand.

UPDATE: Calculated Risk reviews the Department of Energy forecasts (although I'm guessing many of you may be visiting here from there.)  Hat tip to CR as well, for pointing out a post at Angry Bear that provides some of the distributional detail behind the "what oil price will cause a recession" question in the Wall Street Journal survey I noted yesterday.

THEY JUST KEEP TICKING: Yet more at Calculated Risk and at Angry Bear.

AND MORE: CR is posting at AB.

April 8, 2005 in Energy | Permalink


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Listed below are links to blogs that reference Energy Prices: Not The 1970s Redux (?) :

» MACROBLOG ON ENERGY PRICES from Knowledge Problem
Lynne Kiesling Here's a nice post on energy prices at Macroblog (and he's even one of my homies, who knew?) that is worth a read. Yes, as he points out, oil importing countries do see the increase in oil prices... [Read More]

Tracked on Apr 8, 2005 3:00:45 PM

» MACROBLOG ON ENERGY PRICES from Knowledge Problem
Lynne Kiesling Here's a nice post on energy prices at Macroblog (and he's even one of my homies, who knew?) that is worth a read. Yes, as he points out, oil importing countries do see the increase in oil prices... [Read More]

Tracked on Apr 8, 2005 3:02:10 PM

» A Permanent Oil Shock? from Deinonychus antirrhopus
The IMF is predicting that the current oil prices are going to be here to stay. I am usually suspicious of these kinds of doom and gloom forecasts as they tend to make an implicit assumption that there is no response these high prices. The basis for th... [Read More]

Tracked on Apr 8, 2005 5:38:29 PM

» Oil Imports as % of GDP from CalculatedRisk
Dr. Altig's graph this morning compared US energy production and consumption (in BTUs) divided by real GDP. Altig defines the difference between consumption and production as our energy dependence. The following graph shows another measure of energy ... [Read More]

Tracked on Apr 8, 2005 8:00:16 PM

» The End oF Empire from BOPnews
Hobson's Choice a blog run by James R MacLean, has been dealing with international economics and American trade flows for some time. His comments here should be of interest, since they are generally in line with the ideas that many... [Read More]

Tracked on Apr 13, 2005 12:41:18 AM


This looks like an extremely interesting graph, but I don't fully understand it.

1) Does this graph relate to US consumption and production (I suppose) or does it relate to OECD consumption and production ?

2) Was it produced by the US energy agency ?

Obviously, it can't relate to the world, or we would likely be in negative inventory territory !

Posted by: godement | April 08, 2005 at 09:30 AM

"That says to me we should not be so quick to dismiss analogies with the situation in the 1970s."

Another point is that in 70s GDP was mostly manufacturing and today GDP is mostly services. That's where "energy efficiency" roots or some of them in.

Demand for manufactured goods are up significantly over last 30 years thanks to more affordable prices brough by globalization. It created pressure on the commodity prices. Producers moving from the US to China do not care about commodity prices much, because they get major boost of profitability from lower labor costs - means higher "added value"

We can expect two major outcomes. One is that retail stores will fail to meet expectations - revenues will go down together with prices and higher profitabilty will not help much to the bottom line. Some costs are fixed no matter how efficient your business is.
The second outcome that we are entering or entered 3 years ago 5-10 years cycle of growing commodity prices.

Let's think about it. Average US consumer working in a bank, keeping 3 cars in a garage of 1200 sq feet house does not produce anything. Still ability (perceived) of US consumer to buy manufactured goods remains high.

To some extend it can be argued that US consumer subsidise China.

Posted by: arkady | April 08, 2005 at 01:07 PM

Leapfrogging off the previous comment it's worth considering that the Chinese economy is considerably more energy intensive than the U. S. economy is. And the energy intensiveness of the Chinese economy is rising rather than falling with wealth. Yes, the United States is the world's champ in energy consumption. But China isn't far behind and is catching up fast.

Posted by: Dave Schuler | April 08, 2005 at 01:54 PM

BG --
The data is indeed for the U.S. The source is the Department of Energy (the Energy Information Administration to be specific: http://www.eia.doe.gov/).

Posted by: Dave Altig | April 08, 2005 at 02:41 PM

There is a 2nd Angrybear post (mine) and yes, CR had a very good discussion but you have had two very good posts on this topic in 1 week!

Posted by: pgl | April 08, 2005 at 03:54 PM

Ms. Baum is not very good at empirical questions, or theoretical questions for that matter. But whether the funds rate should go up or down in response to an oil price surge depends on how well inflation expectations are anchored and on the relative propensities to spend out of transitory income among producers and consumers of oil. It is plausible that the Fed would have to cut the funds rate to 1%
to stabilze the prospective rate of inflation prospectively if the price oil were to rise to 100 dollars.

Ms. Baum's reductio is not convincing. And I am surprised you would accept as obvious her policy prescription even while correctly pointing out that she makes a fairly serious mistake, a confusion of supply and demand.

Posted by: Gerard MacDonell | April 10, 2005 at 07:47 PM

Gerard --

I interpreted her policy observation to be that the Fed cannot offset the effects of a negative supply shock by printing more money. I certainly agree with that point.


Posted by: Dave Altig | April 12, 2005 at 08:46 AM

Gerard has a point here. Baum (who has a tendency to claim expertise in many things, and say silly things in the process), seems to be arguing that appropriate Fed policy in case of a supply shock is the same as appropriate Fed policy in the face of a demand shock.

Reason? Because easing in the face of either doesn't "seem" right. There ought to be at least something like an argument attached.

I think we can agree that the standard central bank response to prices rising due to an outward shift in demand is tighter policy. It is far from clear that an inward shift in supply calls for the same response.

It may be that the Fed is helpless to influence oil output, thus cannot remedy an oil supply shock directly. That is not the same as saying the Fed has no power to mitigate the impact of an oil shock as it is transmitted through the economy.

Posted by: kharris | April 12, 2005 at 04:16 PM

The correct response to such a supply shock is tightening by the central bank. This was what Paul Volcker argued for, and did, in response to the 1979 supply shock.

Posted by: Stirling Newberry | April 13, 2005 at 12:45 AM

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