I wasn’t alive for the oil crisis of the 1970’s, but I’ve heard stories - the rationing, the license plates, the long periods of waiting that must have made a driver think twice about commuting to work. Economists have always blamed the crisis - and the periods of low growth, high unemployment, and high inflation - on instability in the Middle East, with the Yom Kippur war in 1973 and the Iranian revolution in 1979.
Now the situation in the Middle East is even stickier. For starters, there’s the Iraq war and the war on terror, neither of which are going smoothly. Add that to fears of foreign dependency, energy insecurity, and peak oil. The price of oil is definitely going up. But the gas lines aren’t snaking around the block, and you’re not seeing fewer gas guzzlers on the road. So what’s the deal?
MIT macroeconomist Olivier Blanchard wrote a paper on why conditions today are so different from the ’70s, which you can read here. And in this interview with Sarah Wright of MIT, he explains how policy - and the interests of everyday workers - affects oil and the economy.
Four price-doubling oil shocks have occurred in 35 years - 1973, 1979, 1999 and now. How have economic reactions differed?
Olivier Blanchard: In the 1970s, there were two sharp recessions and sharply higher inflation. This time around, the economy has remained strong, and inflation has barely bulged.
What’s behind the differences? Why was 1973 so different from 2007?
In the 1970s, the adverse effects of oil price increases were compounded by other adverse shocks - a sharp slowdown in productivity growth and large increases in the price of raw materials.
In the 2000s, the effects of oil price increases have been partly offset by other shocks, this time favorable-sustained productivity growth and strong Asian growth, for example.
Higher oil prices make dramatic news, yet your research indicates oil actually affects the U.S. economy less than it did 35 years ago. Why is that?
Those previous large increases in the price of oil did their job: they led to decreased demand. The share of oil and gas in U.S. production and consumption today is roughly two thirds of what it was in the 1970s. Thus, any given increase in the price of oil has only two-thirds of the impact it had then.
Do oil prices still affect wages, as they did in the 1970s?
Oil doesn’t have the impact it did because workers don’t have the bargaining power they did. In the 1970s, oil price increases led workers to try to maintain their purchasing power by seeking higher wages, which they often won through union contracts. This increase in wages led in turn to an increase in the price of all goods, which led to a further increase in wages and so on.
In the 1970s, wage increases were also made easier by the fact that, in many countries, wages were indexed to inflation, so they automatically went up. To fight inflation, central banks tightened monetary policy, leading in turn to declines in output. Things are very different now: Indexation clauses are largely gone. And workers’ bargaining position is much weaker than in the 1970s. Thus, for the most part, wages have not gone up with the price of oil, and inflation has remained low. There has been no need-so far-for tighter monetary policy.
What role has monetary policy played in differentiating the 1970s from the 2000s?
For the last 25 years, monetary policy has aimed at stabilizing inflation, and people have come to rely on it as a credible policy. Now, when the price of oil increases, workers do not anticipate impending inflation and thus, do not feel they have to ask for large wage increases.
Are there any macroeconomic benefits to higher oil prices?
Higher oil prices have many complex implications for the world economy. Let me just take one, which may seem paradoxical: The increase in the price of oil helps finance the U.S. current account deficit. The reason is that oil producers know that oil revenues will not last forever, so they save a good part of those revenues. Not having great investment opportunities at home, they are eager to lend outside their country, and, in particular, to lend to the U.S.
Such willing creditors allow the U.S. to continue to borrow abroad and to run a large current account deficit. Were it not for oil-producing countries, the demand for U.S. assets would be smaller, and the dollar would be even weaker than it is today.
What if oil-producing countries suddenly took their money out?
The dollar would plunge. But so would the value of their dollar investment, so they are very unlikely to use this tool/threat.
Will the price of oil keep going up?
I truly have no clue - despite talking to many of the people whose job it is to forecast oil prices. Most believe that based on what we know about the elasticity of supply and the elasticity of demand, the current price is surprisingly high. At 90 or 100 dollars a barrel, there is a lot of oil worth extracting, and a lot of alternative energy sources worth exploiting. Futures markets do not predict much change from current levels; this seems a reasonable assumption.
(Thanks to the MIT News Office)
Interesting that Blanchard cites “strong Asian growth” as cushioning the impact of rising oil prices. For China, you can pretty reliably take 10 percent economic growth per year to the bank. I can only hope that we don’t relive the gas lines of the 70s anytime soon.
The price of oil has less impact than in the 1970s because oil is a smaller part of total GDP. What affected total GDP then and will cause a major depression now will be a shortfall in the SUPPLY of oil. We can, to an extent, afford to pay four times as much for oil. Ultimately that money is recycled by the suppliers back into the economy. However, if the global SUPPLY of oil falls, then there is less oil to translate into GDP, and each unit of oil generates about 14 units of GDP. No oil - No economy. The global stock of oil in the ground is finite. The rate at which we can pump it out of the ground is finite, and for geological reasons, declining. Therefore the global supply of oil is finite and declining. As long as we could afford to out-bid the rest of the world for the oil we need, no problem. Those days are over. Depression, here we come.
I agree with one thing you say. “[you] truly have no clue”
Just look around you and read between the lines of the Main Stream Media and the “oil experts” and you will see the truth.
There were gasoline queues and gasoline rationing because gasoline was subsidized. Since then it has been negatively subsidized: taxed at higher rates than other commodities.
Gold’s value always remains the same.
Only the value of currency to buy Gold changes.
So what’s the value of your currency today?
I’ve lived this age. I almost remember it like it was yesterday. You forgot to mention the hostages taken by Iran. For the US the main culprit was Jimmy Carter and his policies during this period turned me from a Kennedy Democrat to a Reagan Republician and gave this country double digit inflation. The curent list of canidates for The Prendency haven’t learned from History and want to repeat the same mistakes Carter made.
What made the gas lines of the ’70’s was a an atrificial shortage of supply — the Arab Embargo. The arabs quickly learned that they needed our money more than they needed their oil, so they developed a strategy of sucking the money out of the US by creating a global monopoly of suppliers, holding down supply to drive up the price. Voila, oil at $90 bucks a barrel.
Of course the price of oil will continue to rise. There were 21 million new cars sold to First Time Car Buyers (these folks had never owned a car before in their lives) in China, India, and Eastern Europe in 2006. The numbers are not in for 2007 yet, expect them to be higher — these new cars run on gas too, and what is driving price is the constant rising demand.
An earlier poster was correct, we are willing to pay the extra cost as long as we can have our drug, and pass the extra expense on to others. The ’70’s was an artifical eduction of supply, we had no gas at the pumps because we had no oil to refine.
Dover