Accounting for the declining economic effects of oil price shocks

Abstract

Many studies have concluded that the effects of oil price shocks have diminished since the mid-1980s. This paper revisits the evidence in Blanchard and Galí (2010)​. I show that the apparent instability in the oil price-macroeconomy relationship they find can be accounted for by the endogeneity of oil price changes and the lower energy share in consumption in recent decades. When these two factors are taken into account, the effects of oil price shocks on real economic activity appear to be stable over time. Nevertheless, the impact of oil prices on inflation has noticeably weakened. • Blanchard and Galí (2010) find that the impact of oil price shocks on the US economy has declined since 1984. • I replicate their key result and show that it is not driven by the persistence of oil prices or the oil price volatility. • I extend their model in two ways. First, I weight oil price growth by lagged energy share in consumption. • Second, I augment their model with a newly constructed measure of non-OECD petroleum consumption. • I show that the extended model implies stable impact of oil price shocks on US GDP and employment.