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Understanding the Impact of Oil Shocks

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  • Aguiar-Conraria, Luis

    (Cornell U and NIPE, U of Minho)

  • Wen, Yi

    (Cornell U)

Abstract

This paper provides new empirical evidence on and theoretical support for the close link between oil prices and aggregate macroeconomic performance in the 1970s. Although this link has been well documented in the empirical literature and is further confirmed in this paper, standard economic models are not able to replicate this link when actual oil prices are used to simulate the models. In particular, standard models cannot explain the depth of the recession in 1974-75 and the strong revival in 1976-78 based on the oil price movements in that period. This paper argues that a missing multiplier-accelerator mechanism from standard models may hold the key. This multiplier-accelerator mechanism not only exacerbated the impact of the oil shocks in 1973-74 but also helped create the temporary recovery in 1976-78. This paper derives the missing multiplier-accelerator mechanism from externalities in general equilibrium. Our calibrated model can explain both the recession in 1974-75 and the revival in 1976-78.

Suggested Citation

  • Aguiar-Conraria, Luis & Wen, Yi, 2005. "Understanding the Impact of Oil Shocks," Working Papers 05-01, Cornell University, Center for Analytic Economics.
  • Handle: RePEc:ecl:corcae:05-01
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    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications

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