Impact of Oil Prices on the US Economy Essay Example | Topics and Well Written Essays - 1750 words

Impact of Oil Prices on the US Economy - Essay Example Although the rise in prices of oil has been large it has not been sudden and the economies of the major economic powers have adjusted to the change. The rise in oil prices will definitely result in an across the board change in prices and thus inflation rates will continue to be high. However the likelihood of this leading to a recession in the US and other large economies of the world is remote. Over the last five years, US natural gas markets have known three major price shocks and have continued to present extremely high volatility (BNP-Paribas). In the past sudden increases in the prices of oil have been followed by sharp increase in inflation, followed by a recession. Again there has been a sharp rise in the prices of oil and it is necessary to understand what effects this can have on the economy and take corrective action where possible and required. With the experience over the last 40 years it is now possible to arrive at a clearer picture of what effects an oil price shock can have. Economists have developed conceptual frameworks to assist in understanding the effects of a sudden increase in any of the inputs to production, that is, labour and capital. These models can be extended to include the effect of oil price shock to allow analysis of the effects of such an event. The political events in the Middle-East, that led to rise in the price of oil, and their relation with the recessions in the US economy, since the first big rise in 1973, are listed in Table 1, enclosed. An examination of this information shows the political events in the Middle East that led to price rise of oil and the recessions during the same period. There does not seem to be an immediate relationship between the two, but if we factor in other information such as the timing of the interference of the central banks/ Government by adjusting interest rates and other fiscal measures to bolster the economy, the stocks of oil at the time of the rise in prices and also the size and performance of that segment of the economy which is not connected directly to the price of oil. As the development rates of the world economy reach all time highs the recession another oil price hike may cause will be difficult to control, since simultaneously interest rates are already very low and further tightening of money supply would yield very marginal results. Because of the phenomenal growth of the world economy things have become quite different from what was historically normal. Real oil prices have reached twice their average over the past two decades, Bond yields have reached the lowest ever levels, American savings are at record lows while the current-account deficit is at a record high (Woodall P, 2006). Discussion Rise in prices of gasoline hit us all