Oil Prices and the Economy

Turmoil in the Middle East is once again helping to unsettle the market for oil and testing nerves in central banks and economics ministries. The benchmark price of crude subsided a little from the high it touched on May 17th, but at around $40 a barrel on May 20th, oil is still dear enough to make economic policy much more complicated than anybody except OPEC would have wished during the next few months.

It is true that even at $40 a barrel, oil is still far cheaper in real terms than it was during the spikes of the 1970s. But don't relax too much: oil caused a worldwide slump back then, let's not forget. At the current price, oil may be incapable of causing mass unemployment, double-digit inflation, extraordinary political turmoil and losses of global economic welfare on a scale hitherto associated with total war—but just how reassuring is that? If oil is only $10 a barrel higher than it would otherwise have been, and stays there a while, prices in general will rise, output and incomes will be reduced, and unemployment, at least for a while, will be raised. That vicious combination of higher inflation and lower growth—stagflation, to recall a term from the 1970s—is about the worst scenario an economic policy-maker can contemplate. Economies may not be as exquisitely sensitive to oil as they were 30 years ago, but make no mistake, oil still matters (see article).

We should keep the oil issue in mind as we factor assumptions into our future economic growth plans.

Here for more.