Are the macroeconomic effects of oil-price changes symmetric?

Carnegie-Rochester

Conference

Series on Public Policy 28 (1988) 369-378

North-Holland

"ARE THE MACROECONOMICEFFECTS OF OIL-PRICE CHANGES SYMMETRIC?" A COMMENT JAMES 0.

HAMILTON

University

Tatom of

two

analyzes

broad

the

classes

on lagged key of

measures

nominal

GNP that

increase

in

data

functions

energy

real

from

estimated

that

increases

stability

price

decreases

not

correlation,

‘If

one had an expression In GNPt

the l

effects

a4).

of

a given

Because of

instantly *By

just

off

the

-

the coefficient

“e I ast i c i t-y” here

A particular energy prices. estimated parameters should

refer

aggregate

the

are

of

economy

agree

prices. in

A

the

level a

on

l%four

1. production

prices

empirical

and inputs elasticities

stability

added

to

symmetry, as

that

the

to data

of

the

that

much

evidence

energy

price

robustness

1981-85 but

from

these

regression. is,

as

apparent

= X+ + a,iT

on In GNPt in Tatom’s to

the

a

of

across

a

+ Asia,’

by (a0

regression,

this

relating

output

+ a,

+

. . .

sum can be read

(2).

coefficient

theoretical

. . .

would be given

this

equation

model might as

+

In GNPt_5)

pafameterizes

simply

used

+ aliF_,

imply

that

some other

elasticity,

(1981).

0 167 - 2231/88/$03.5001988

regressed

2 and 3.2

1981-85

respect

energy

numerical

the

structural be

estimates

the

is

based

in Table

evidence

actually

on AiF_, I

elasticity

to

augmented

form

in iT_4

way Taton

this

terms

of

following

sumnarized

as

with

In GNPt_,

change

quarters

help must

of the

change

some of

from

One certainly

hurt.

and energy

output

to

GNP growth

policy,

in Tables

attention when data

this

energy

this

regressions

our

elasticities

He interprets

regressions

business-sector

these

calls

of are

and GNP in

consists

percentage four

I have collected

and labor.

Tatom

the

Estimates

of

nominal

predicted

and specifications

relating

as estimated

be 1

is

prices

class

fiscal

policy,

regressions

prices.

sets

class

capital

in which

monetary

would

energy

The first

regressions.

these

second

The

of

of

from

Virginia

between

regressions,

statistic

different

correlation

of

Andersen-Jordan-style

of

Elsevier Science Publishers 8.V. (North-Holland)

as

in

to

the

function Rasche

log of of

the

and Tatom

TABLE

Elasticity with

Respect as

to

of Energy

Estimated

from

Study

Level Price

Tatom

(1981) and

Goodwin

(1986)

of

Nominal

Changes

U.S.

Four

GNP

Quarters

Andersen-Jordan-Style

Sample

Gisser

I

Earlier,

Equations

Period

Elasticity

1955:1-1978:lll

-.099

1%1:1-1982:Iv

-.ll

Tatom

(1987)

1955:1-1980:111

-.Q92

Tatom

(1987)

1955:1-1986:llI

-.

TABLE

Elasticity as

Measured

by

of

Level

Production

of

Function

Study

Output

2

with

Estimates

Sample

102

Respect for

to

U.S.

Energy

Real

Prices

Business-Sector

Period

Output

Elasticity

Rasche

and

Tatom

(1977)

1949-73

-.13

Rasche

and

Tatom

(1977)

1949-75

-.I4

Tatom

(1987)

1948-80

-.053

Tatom

( 1987)

1948-85

-.055

TABLE

Elasticity as

of

Foreign

Country

Real

of by

Output

with

Respect

Production

Function

Business-Sector

Output

Time

Period

to

Energy

Estimates by

Tatom

Prices for

(1987)

Elasticity

Canada

1961-83

-.082

France

1964-83

-.124

1962-83

-.129

1963-83

-.I38

Italy United

Level

Measured

3

Kingdom

370

large number of different data sets and techniques is quite striking. The

key

question

is,

what

economic

forces

account

for

this

In my view, the search for a satisfactory explanation

correlation?

of

either set of regressions must focus on the short-run cyclical consequences Much of the correlation between energy prices and

of energy price shocks.

GNP that Tatom has documented may well be coming from events immediately associated with economic recessions (Hamilton 1983, 1985). magnitude

of

the

elasticity

estimated

from

many

exceeds the value share of energy in total output.

of

Moreover, the

these

regressions

The marginal product of

energy is given by its relative price; thus the effect of energy shortfalls should be bounded by energy's dollar share in total GNP.3

To the extent

that a decline in GNP greater than this magnitude is observed, utilization of some other factor of production must be falling along with energy use, and such changes in utilization may well be part of the business cycle as distinct from long-run trends. Employment of labor is the first place one might look for such shortHere one can choose

run changes in utilization. regard

the

resulting

unemployment

as

involuntary

between accounts that --

unemployment

that

arises from the failure of wages and prices to adjust instantly to marketclearing levels -- and those that treat it as voluntary -- unemployment that would be present even with perfectly flexible wages and prices. labor's marginal

If

product falls with

decreasing

energy

might anticipate some voluntary substitution into leisure.

use,

one

Tatom does not

advocate such an interpretation, and, I presume, for an excellent reason. The secular trend over the last hundred years is towards higher real wages and a shorter work week.

It is accordingly most difficult to defend a

strong positive elasticity of labor supply with respect to the real wage if one

is

talking

about

a permanent

change

in the marginal

product

of

a

representative worker. This observation motivates Lucas's (1977) and Kydland and Prescott's (1982) attention to explicitly short-run substitution effects

3That

is, 3

holding

In

Y

aY

a

In

E

aE

a

ln

Y

-z-f

capital

and

E

labor

constant,

PE-E

_=Y

Py’Y

and

a in Y =

a in (pE/py)

a

In

E

-.

a

In

E

a 10 (P~/PY) 371

associated

with business-cycle frequencies.

A temporary reduction in labor's marginal

product may well induce a temporary increase in leisure, if there is some substitutability

characterizing

short intervals of time.

labor-leisure

tradeoffs

over

relatively

By contrast, a permanent drop in marginal product

need not affect employment.

Tatom's assumption that energy price changes

matter for aggregate supply primarily to the extent that they are perceived as permanent is thus fairly specific to the particular model he has in mind for the supply side of the economy. The alternative approach emphasizes wage rigidities as responsible for an

increase

in

involuntary

marginal product.

unemployment

following

a

fall

in

labor's

This theme has been ably developed by Phelps

(1978),

Mark and Hall (1980), and Bruno and Sachs (1985), among others. In both of the above examples, the temporary decline in employment is caused

by

a

decline

in the

marginal

product

of

An

labor.

oil

decrease presumably would have a symmetrically opposite effect. this conclusion

price

However,

assumes that the effects of lower energy use on labor's

marginal product represent an aggregate disturbance across all sectors.

An

oil price increase may produce a boom in the Texas oil fields and a slump Even if the dollar magnitudes of the initial shocks to the two

in Detroit. sectors

balance

each other

there

out,

are

real

short-run

technological

costs associated with shifting labor and capital between the two sectors. Resources may be idled during this shift, or alternatively may be idled if workers and firms decide to wait things out, hoping for an improvement of local conditions. emphasized capital (1982). price

by

has

Ricardo

received

A

(1817). renewed

life

Recent models developing

shocks

Hamilton

The importance of sector-specific physical capital was

have been presented

(1988).

investigated

Moreover,

regressions

in

related

perspective

stressing

in

provocative

work

the

of

human Lilien

Lilien's theme in its relation to oil by

Davis

both

Davis

which

the

(1985), Loungani (1984)

and

empirical

(1985), and

Loungani

(1986)

specification

was

explicitly asymnetric -- unemployment was related to the square rather than the

actual

value

of

oil

price

changes

--

and

reported

a

superior

statistical fit. In addition to adjustments

in labor, the other factor of production

that might account for potential multiplier effects is capital. Manne (1977) and Rasche and Tatom (1981), if the

long-run real

interest rate

Hogan and

among others, have suggested that

is fixed

by time preference,

then a

short-run reduction in capital's marginal product (occasioned by decreased energy use) will ultimately require a reduction in the steady-state ratio 372

of

capital

to

and

theoretically,

While

labor. would

again

it is difficult

connection, energy-price

elasticity

Rasche and Tatom

this

effect

motivate

symmetry

to believe that

reported

the

in

is

certainly in

the

it accounts

plausible

energy-output for

Andersen-Jordan

the

large

regressions.

rightly noted that the adjustment of the capital

(1981)

stock is surely a fairly long-run process.

Moreover, a reduction in the

capital stock is likely to be achieved, at least in the neoclassical growth If one wants

model, by an increase in aggregate spending on consumption.

to arrive at a recession by this mechanism, there must be other factors operating, such as putty-clay technology or rigidities in prices magnifying the consequences of reduced investment demand or lower capital utilization Along this same vein, if capital is putty-clay, uncertainty per se

rates.

about the future course of input prices can motivate a delay in investment commitments decrease

(Bernanke,

1983;

Pindyck

in investment demand

could

and

Rotemberg,

1983),

be a factor contributing

and

this

to rising

unemployment in either the Keynesian or sectoral-shifts account.

Again,

this is a potential asymmetry in the effect of energy shocks arising as a consequence

of

short-run

technological

or

nominal

rigidities

in

the

economy.

To summarize, I find Tatom's theoretical arguments for the symmetry hypothesis unconvincing.

Sectoral shifts and short-run uncertainties seem

likely to play an important role in accounting for the correlations that Tatom

and

others

have documented,

inconsistent with the s-try What then do assembled

and these propagation

for

the

in favor of the falling

are

I make of the empirical evidence that Tatom has ably synaaetry hypothesis?

The apparent

stability of the estimated elasticities reported certainly offers

mechanisms

hypothesis.

oil

prices

of

1981-85

support for Tatom's

are

view of

numerical

in Table 1-3, when data

added

to

symmetry

the

regressions,

in the relation.

However, the Andersen-Jordan regression is stable only when a dummy term for a growth shift beginning in 1981

is added to the regression.

If

the

same linear specification were used as in the earlier period, falling oil prices

(and rapid Ml

growth) would

growth than was actually observed. growth

shift

is a consequence

period rather than as-try

of

have led one to predict faster GNP Tatom's interpretation is that this

the decline

in Ml velocity over

this

in the effects of oil prices on the economy.

It is unclear how one would prove or disprove this claim on the basis of these data.

In any case, it seems unlikely that falling oil prices played

no role in the decline in Ml velocity. 373

Indeed, other regressions presented

by Tatom suggest that falling oil prices made some contribution to lower rates of inflation, and decreases in expected inflation are widely cited as a principal cause of the decline in the velocity of money.

Tatom does test

for interaction between the dummy and energy price coefficients and finds no

statistically significant relation.

However,

acceptance of

the null

hypothesis here may simply reflect the low power associated with trying to estimate seven new coefficients from five years of quarterly data. The

results

from

the

production-function

similarly sensitive to the

role of

regressions

trend terms

seem

to

for productivity

be

growth

I think it is a fair

shifts thought to have occurred in 1967 and 1977.

sumnary of the literature to say that both the timing and the ultimate causes of the productivity

slowdown remain a mystery to economists

(e.g.

Tatom's trend productivity terms may well be completely

Denison, 1979).

exogenous with respect to changes in the energy price regime, but if one were not persuaded of that proposition a priori,

it is not clear how one First-

should interpret the stability of these relationships after 1981. differenced

data

without

the

trend

terms

point

to

a

decrease

in

the

estimated output-energy price elasticity once the period with falling oil prices

added

is

to

the

regression

analysis,

a

result

less

strongly

on

the

dramatic

evaluate

the

symmetry

supportive of the symmetry hypothesis. Tatom decline

argues

in oil prices

other

we

now

have

ample

1981, with

since

data,

which

to

based

However, to the extent that this decline roughly coincides

hypothesis. with

that

important

such

trends,

as

the

decline

in

Ml

velocity

and

exogenous changes in productivity growth, it is difficult to separate the effects. changes

Moreover, in

relative

the

sectoral-shifts

prices

force

the

hypothesis

costly

argues

reallocation

that

of

sharp

labor

and

attributes the resulting increase in unemployment to delays in finding new The

jobs.

therefore

predicted

quite

(Davis, 1987). equally

effects

different

of

a given change

depending

on

the previous

The sharp oil price decline

sharp run-up

in oil

prices

in relative prices

seen

pattern

of

are

changes

in 1981 simply reversed the

in the

It is

previous year.

certainly possible that many of the workers displace by the previous run-up in oil prices simply got their old jobs back in 1982, in which case the oil price

decline

employment

and

of

1981 would

GNP,

according

indeed to

the

have

been

a

factor

sectoral-shifts

in

boosting

hypothesis.

By

contrast, no similar story could be told for the oil price collapse of 1985, which followed a long period of gradually declining oil prices.

An

interesting test of the competing hypotheses would thus be to see whether 374

the coefficients of Tatom's equation (2) are stable across 1985:1-1987:IV; the

symmetry

hypothesis

says

that

hypothesis holds that they would not.

375

they

would,

the

sectoral-shifts

REFERENCES Bernanke, B.S. (1983)

Irreversibility, Quarterly

Journal

Uncertainty,

Cyclical

and

Investment.

98: 85-106.

of Economics,

Bruno, M. and Sachs, J.O. (1985)

Economics

of

Worldwide

Harvard

Cambridge, MA:

Stagflation.

University. Davis, S.J. (1984)

Allocative Market

Disturbances

and

Temporal

Asymmetry

Unpublished manuscript,

Fluctuations.

in

Labor

University of

Chicago, Graduate School of Business.

(1985)

Sectoral Shifts and the Dynamic Behavior of Unemployment: Theoretical Analysis.

A

Unpublished manuscript, University of

Chicago, Graduate School of Business.

K. Brunner

Fluctuations in the Pace of Labor Reallocation.

(1987)

and A.H.

(eds.) , Empirical

Meltzer,

Exchcmge

Rates,

Unemployment

and

Studies

of

Velocity,

Real

Carnegie-

Productivity,

Rochester Conference Series on Public Policy, 27.

Amsterdam:

North Holland. Denison, E. F. (1979)

Accounting for Slower

Economic

Washington, D.C.:

1970’9.

Growth:

The United

States

in the

Brookings Institution.

Gisser, M. and Goodwin, T.H. (1986)

Crude

Oil

Notions.

and Joumal

the

Macroeconomy:

Tests

of Money, Credit and Banking,

of

Some

18:

95-103.

Popular

Hamilton, J.D. (1983)

Oil

and

the

Macroeconomy

Political Economy,

Since

91: 228-248.

376

World

War

II.

Journal

of

Hamilton, J.D. (1985)

Historical Energy

(1988)

A

Causes

Postwar

Oil

Shocks

and

Recessions.

6: 97-116.

Journal,

Model

Neoclassical

Cycle.

of

of

Unemployment

and

the

Business

Forthcoming , Journal of Political Economy.

Hogan, W.W. and Manne, A.S. (1977)

Interactions: The Fable of the Elephant

Energy-Economy the

Modeling

Rabbit?

Energy-Economy

(ed.) C.J. Hitch.

Approaches,

Five

interactions:

Washington,

and

O.C.:

Resources

for the Future. Kydland, F.E. and Prescott, E.C. (1982)

lime to Build and Aggregate Fluctuations.

Econometrica,

50:

1345-1370. Lilien, D.M. (1982)

Sectoral Shifts and Cyclical Unemployment. Economy,

90:

Journal of Political

777-793.

Loungani, P. (1985)

Oil

Prices,

Dispersion

and

Unemployment,

1900-1929.

Unpublished manuscript, University of Rochester.

(1986)

Oil Price Shocks and the Dispersion Hypothesis. Economics

and Statistics,

58:

Review

of

536-39.

Lucas, R-E., Jr. (1977)

Understanding Business Cycles. International Public

Economy.

Policy,

Amsterdam:

5,

Stabilization

of the Domestic

and

Carnegie-Rochester Conference Series on (eds.)

K.

Brunner

and

A.

H.

Meltzer.

North-Holland.

Work, K.A. and Hall, R.E. (1980)

Energy Journal.

Prices,

Inflation,

1: 31-63. 377

and

Recession,

1974-75.

Energy

Phelps, E.S. (1978)

Commodity-Supply Shocks and Full-Employment Monetary Policy. 206221.

10:

Journal of Money, Credit and Banking, Pindyck, R.S. and Rotemberg, J.J. (1983)

Dynamic

Factor

Demands

Shocks. American

and

the

Effects

of

Energy

Price

73: 1066-1079.

Economic Review,

Rasche, R.H. and Tatom, J.A. (1977)

Energy Resources and Potential GNP.

Energy Price Shocks, Aggregate The

and

Theory

Incentives, Series

on

Meltzer.

Bank of St.

59 (June): 10-24.

Louis Review,

(1981)

Federal Reserve

Supply, and Monetary Policy:

International

and National Public

Supply

shocks,

Carnegie-Rochester Conference

Wealth.

Policy,

Amsterdam:

Evidence.

14,

(eds.)

K.

Brunner

and

A.H.

North-Holland.

Ricardo, Cl. (1817)

On

the Principles

University

of Politicat

Press edition,

Economy

and Taxation.

Cambridge

(ed.) P. Sraffa, Cambridge,

1951.

Originally published in 1817. Tatom, J.A. (1981)

Energy

Prices

and

Short-Run

Reserve

Bank of St. Louis Review,

378

Economic

Performance.

63 (January)

: 3-17.

Federal