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The Real Price of Oil and the 1970s World Inflation

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  • Michael R. Darby

Abstract

This paper shows that the effects on real income and the price level of the 1973-1974 oil price increase are quite ambiguous on both theoretical and empirical grounds. The theoretical analysis reviews standard results and extends them to analyze the steady-state equilibrium and endogenous monetary policy reaction functions. It is shown that standard models and parameter values imply trivial reductions in real income and ambiguously signed changes in the price level. It is noted, however, that other special models can rationalize empirical findings of large effects. Direct real- oil-price effects in an extended Barro-Lucas real income equation are estimated for eight countries. Although statistically significant and substantial direct effects are found for about half the countries, it is noted that these coincided with countries undergoing price decontrol during 1973- 1974. Thus price-control biases in real GNP data provide an acceptable alternative explanation for the estimated effects. Simulation experiments in an international model illustrate the wide range of real income and price level effects which are consistent with the data. Further research is proposed to narrow the range of possible effects.

Suggested Citation

  • Michael R. Darby, 1981. "The Real Price of Oil and the 1970s World Inflation," NBER Working Papers 0629, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:0629
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    1. Michael R. Darby & James R. Lothian & Arthur E. Gandolfi & Anna J. Schwartz & Alan C. Stockman, 1983. "II. The Mark III International Transmission Model," NBER Chapters, in: The International Transmission of Inflation, pages 83-84, National Bureau of Economic Research, Inc.
    2. Knut Anton Mork & Robert E. Hall, 1980. "Energy Prices, Inflation, and Recession, 1974-1975," The Energy Journal, International Association for Energy Economics, vol. 0(Number 3), pages 31-64.
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    6. Lucas, Robert E, Jr, 1973. "Some International Evidence on Output-Inflation Tradeoffs," American Economic Review, American Economic Association, vol. 63(3), pages 326-334, June.
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