Petroleum Price and Economy

Petroleum Price and the Economy Summary

Oil prices remain a significant determinant of global economic performance. Overall, an oil-price advance leads to a transfer of income from importing to exporting countries through a shift in the terms of trade. The enormity of the direct effect of a given price boost depends on the share of the cost of oil in national income, the degree of dependence on imported oil and the ability of end-users to lessen their consumption and switch away from oil.

It also depends on the degree to which gas prices rise in response to an oil-price increase, the gas-concentration of the economy and the impact of higher prices on other forms of energy that compete with or, in the case of electricity, are generated from oil and gas. Naturally, the larger the oil-price increase and the longer higher prices are sustained, the larger the macroeconomic impact.

For net oil-exporting countries, a price raise directly increases real national income through elevated export earnings, though part of this gain would be later make up for by losses from lower demand for exports normally due to the economic recession suffered by trading partners.

Variation effects, which result from real wage, price and structural inflexibility in the economy, add to the unswerving income effect. Elevated oil prices lead to inflation increased input costs, reduced non-oil demand and lower investment in net oil importing countries. Tax revenues fall and the budget deficit enlarges, due to rigidities in government expenses, which drives interest rates up.

Because of clash to real declines in wages, an oil price increase typically leads to upward stress on nominal wage levels. Wage pressures together with lessened demand tend to lead to higher short term unemployment. These effects are greater the more abrupt and the more definite the price increase and are magnified by the force of higher prices on consumer and business confidence.

An oil-price increase also changes...