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Oil Price Shocks and the U.S. Stagflation of the 1970s: Some Insights from GEM

Using a variant of the IMF's Global Economy Model (GEM), featuring energy as both an intermediate input into production and a final consumption good, this paper examines the macroeconomic implications of large increases in the price of energy. Within a fully optimizing framework with nominal and real rigidities arising from costly adjustment, large increases in energy prices can generate inflation persistence similar to that seen in the 1970s if the monetary authority misperceives the economy�s supply capacity and workers are able to temporarily resist some of the erosion in their real consumption wages resulting from the energy price increase. In the absence of these two responses, the model suggests that energy price shocks cannot generate the type of stagflation witnessed in the 1970s. The analysis goes some way toward reconciling the results found in the empirical literature on the changing nature of the macroeconomic implications of oil price shocks.

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Energy Specializations: Petroleum – Markets and Prices for Crude Oil and Products; Energy Security and Geopolitics – Energy Security; Energy Modeling – Energy Data, Modeling, and Policy Analysis

JEL Codes:
L13 - Oligopoly and Other Imperfect Markets
Q48 - Energy: Government Policy
E61 - Policy Objectives; Policy Designs and Consistency; Policy Coordination

Keywords: Oil Shocks, GEM model, energy policy, oil prices

DOI: 10.5547/ISSN0195-6574-EJ-Vol27-No4-3

Published in Volume 27, Number 4 of The Quarterly Journal of the IAEE's Energy Economics Education Foundation.