Facebook LinkedIn Instagram Twitter
Shop

This is a Free article. You will receive access to the full text.

Is the Discretionary Income Effect of Oil Price Shocks a Hoax?

Free Article

Abstract:
The transmission of oil price shocks has been a question of central interest in macroeconomics since the 1970s. There has been renewed interest in this question since the large and persistent fall in the real price of oil in 2014-16. In the context of this debate, Ramey (2017) makes the striking claim that the existing literature on the transmission of oil price shocks is fundamentally confused about the question of how to quantify the effect of oil price shocks. In particular, she asserts that the discretionary income effect on private consumption, which plays a central role in contemporary accounts of the transmission of oil price shocks to the U.S. economy, makes no economic sense and has no economic foundation. Ramey suggests that the literature has too often confused the terms-of-trade effect with this discretionary income effect, and she makes the case that the effects of the oil price decline of 2014-16 on private consumption are smaller for a multitude of reasons than suggested by empirical models of the discretionary income effect. We review the main arguments in Ramey (2017) and show that none of her claims hold up to scrutiny. Our analysis highlights the theoretical basis of the discretionary income effect. We also discuss improved regression-based estimates of this effect that allow for changes in the dependence on oil and gasoline imports, and we highlight the fact that alternative estimates used by policymakers involve strong simplifying assumptions.

Download Executive Summary Download PDF

Energy Specializations: Petroleum – Markets and Prices for Crude Oil and Products; Petroleum – Policy and Regulation

JEL Codes: Q41: Energy: Demand and Supply; Prices, Q40: Energy: General, Q35: Hydrocarbon Resources, L71: Mining, Extraction, and Refining: Hydrocarbon Fuels

Keywords: Stimulus; oil price decline; discretionary income effect; expenditure share; gasoline; net oil imports.

DOI: 10.5547/01956574.39.SI2.cbau

References: Reference information is available for this article. Join IAEE, log in, or purchase the article to view reference data.


Published in Volume 39, Special Issue 2 of The Quarterly Journal of the IAEE's Energy Economics Education Foundation.