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Learning to shrug off oil shocks
A recent study by the Dallas Fed suggests the U.S. economy has grown less sensitive to oil prices.
November 17, 2003: 1:24 PM EST

NEW YORK (CNN/Money) - Like peanut butter and jelly, salt and pepper, and J-Lo and Ben, high oil prices and U.S. economic strife just seem to go together. But a recent study by the Dallas Federal Reserve suggests the two might not be as closely tied as they once were.

Nine of the 10 U.S. recessions since World War II have been preceded by a jump in oil prices. The most dramatic examples of this relationship came in the mid-1970s, after an Arab oil embargo, and early 1980s, during the Iran-Iraq war, when oil price shocks triggered severe downturns.

More recently, a surge in oil prices in late 2000 helped set the stage for the 2001 recession, though the direct effect of the oil shock was not as clear cut. A series of Federal Reserve interest-rate hikes, the bursting of the technology stock bubble and other factors helped bring on the decline.

Oil prices surged again in the runup to the Iraq war in early 2003. But even though the economy slowed down dramatically, it apparently managed to avoid a full-fledged recession.

A recent study by economists Stephen Brown, Mine Yucel and John Thompson at the Dallas Fed suggests that such a muted response to higher oil prices may have become the norm in the United States.

"In the late 1990s and early 2000s, rising oil prices had less effect on economic activity than ... might have been expected," the economists wrote.

For one thing, as the U.S. economy has shifted from producing goods to producing services and has learned to use energy more efficiently, it has become less reliant on oil for its economic output -- the ratio of energy consumption to economic growth has fallen more or less steadily since the end of World War II.

The drop in this ratio meant the U.S. economy was about a third less sensitive to oil price fluctuations in 2000 than it was in the early 1980s and about half as sensitive as it was in the early 1970s, the economists said.

Conspicuous consumption

What's more, many of the earlier oil-price shocks were driven by embargoes and wars, in which the global supply of oil was sharply curtailed, forcing oil-consuming industries to slow down dramatically.

Oil and Gas

In contrast, in the late 1990s, oil prices rose mostly because growing industrial powerhouses such as China and Korea ramped up their oil consumption as their factory sectors expanded. Demand-driven price gains are less harmful to oil-consuming U.S. industries than supply-driven price shocks, the economists said.

Finally, U.S. markets and policy makers have become better accustomed to coping with oil-price shocks in recent years, the economists said, which may help explain why higher oil prices have had little impact on core inflation since 1980.

After falling dramatically in the weeks after the U.S.-led invasion of Iraq began in March, oil prices have crept steadily upward, hovering between $28 and $32 a barrel in recent months.

Though some of the recent gains have been driven by tight U.S. inventories and violence in the Middle East, analysts say they've also been caused by increased demand, driven by global economic improvement -- suggesting, according to the Dallas Fed's study, that U.S. economic damage could be limited.  Top of page

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