Slide 5 of 5

Notes:

• What are the macroeconomic impacts of the recent rise in world oil prices? Crude oil price essentially doubled between the first and third quarters of 1999. Consider two hypothetical cases. The first assumes that the price of oil stays constant at $11 per barrel through 1999 and 2000. The second reflects world oil prices rising from $11 in the first quarter to $22 by the third quarter of 1999 and remaining at that level through 2000. The table below highlights impacts on the economy.

 

Impacts of the World Oil Price Rising from $11 to $22 per Barrel
	1999	2000
Increase in CPI Inflation	+0.50 percentage points	+0.75 percentage points
Loss in GDP Growth	-0.50 percentage points	-1.00 percentage points

• CPI Inflation is higher by an additional 0.5 percentage points in 1999, reflecting higher prices for oil and other energy commodities. In 2000, higher prices paid for energy will cycle through the economy and create additional inflationary pressure and CPI inflation is higher by approximately 0.75 percentage points. GDP growth is also affected. For 1999, the growth rate of GDP under the high world oil price case is approximately 0.5 percentage points lower, and in 2000, the reduction in growth is approximately a full percentage point.

• Is there a threshold for concern about the rise in oil prices? On average, world oil prices have been around $20 (in constant 1998 dollars) since 1986. However, in 1990 prices rose beyond $30 dollars and the growth rate of the economy fell below 2 percent in 1990 and became negative in 1991. The current economy is robust, growing at more that 4 percent per year. However, a sustained world oil price of $30 would result in additional inflationary pressure, perhaps as much as 0.5 additional percentage points, and an additional loss in GDP growth on the order of 0.5 percentage points.

• Does the volatility of world oil prices matter? Volatility matters for all consumers and producers in the economy. Business firms, both energy and non-energy, make investment decisions based on expectations about prices. If the decision is made in the expectation of low (or high) energy prices, and the oil market varies sharply, firms may make inappropriate investment and general business decisions. Even those firms that expect volatility may be adversely affected by simply putting off a decision until the market is more stable. Consumers purchases of housing and consumer durables, such as autos and appliances, are also affected by instability in energy markets. The economy would most likely be better off with stable energy prices, than one with fluctuating oil prices, even if the average is the same over the same period.