- General Discussion
Robert Gordon emphasized that oil-price increases were not the only adverse shocks to the macroeconomy during previous episodes. During the early to mid-1970s, most developed countries moved to flexible exchange rates, price controls were lifted, and food prices rose dramatically. Moreover, monetary policy was tightened in the mid-1970s and again around 1980. In contrast, other shocks were mostly absent and monetary policy was much looser during the recent oil-price run-up.
Robert Shiller took a different perspective, noting that the recent oil shock coincides with widespread fear that global economic growth will exhaust the world's natural resources, much as the 1970s oil shocks coincided with the "great population scare." These additional fears may have accentuated the impact of the oil-price shocks in both periods. He also pointed out, however, that there has been much more hedging of oil risks in recent years. William Nordhaus agreed that there is a long history of fear of running out of oil, but he guessed that the objective level of fear is much lower today than it was in the 1970s. There is no evidence that world oil supplies are any closer to depletion than they were in the 1960s and 1970s, so there is probably much less irrational anxiety about it.
Martin Baily wondered whether the absence of widespread inflation following the most recent shock could be attributed to greater credibility of monetary policy, or to labor markets and wage-setting mechanisms that react more favorably to oil-price shocks than they did in the past. William Dickens replied with evidence from the International Wage Flexibility Project about evolving resistance to real wage cuts. He said that whereas 20 percent of the U.S. workforce had been subject to real-wage rigidity in the 1970s, this percentage had fallen to zero by 1990. However, Dickens found this explanation for the recent absence of inflation in the United States unpersuasive, because real wage cuts are still greatly resisted in Europe, [End Page 239] and Europeans have experienced more moderate effects from the sharp rise in oil prices. Because the recent oil shock was more anticipated and less jarring than past shocks, and because the economic and political environment was much more favorable, Lawrence Summers thought it might not be necessary to resort to propagation mechanisms and policy responses to explain why the impact was so much more moderate.
Nordhaus noted that oil shocks boost inflation in two ways: increases in fuel prices account for about half of the overall effect, and indirect increases in airfares, shipping costs, and so on account for the other half. A key question is how monetary policy should handle the indirect effects. Nordhaus proposed that, if possible, it would be optimal to allow these indirect price increases to pass one for one into inflation. This would avoid compressing profit margins or growth rates of nominal wages, which would likely be necessary if policymakers attempted to keep the price level stable. An isolated increase in the price of trucking services might not be cause for concern, but a general increase in wages might signify more troubling inflationary pressures. [End Page 240]