Because oil is an important input in the production process, a significant increase in oil prices can retard economic growth. In April and May, spot crude oil prices rose nearly $10 per barrel; during the second quarter of the year, real GDP growth slowed to 2.8%. Just how sensitive the real economy is to oil price shocks depends on several factors. If the shock is only temporary, then the effect on output will be negligible; a permanent increase in oil prices will have much larger effects. How important oil is to production may also determine how adversely production is affected when its price increases. It is often remarked that oil—and energy consumption more generally—has become a smaller share of the economy over the last 30 years, which might imply that output will be less adversely affected by rising energy prices today than it was 30 years ago. Finally, some analysts believe that where the input is produced may influence how economic output is affected when the input price goes up. In particular, because the U.S. relies far more on foreign sources of oil than in the past, they believe that an oil price increase will affect output more strongly than in the past.
Suggested citation: "Oil," Federal Reserve Bank of Cleveland, Economic Trends, no. 04-09, pp. 09, 09.01.2004.