Global Economy Learns to Absorb Oil Price Hikes

Global economy has built up some resilience to oil price increases

Sharp price hikes due to supply disruptions remain a concern

Supply disruptions could upset growth in the U.S. and Europe

During the current economic downturn, the price of oil hit over $100 a barrel, and prices rose close to levels only seen in the 1970s. But the increases have not triggered global recessions as they did in the 1970s and 80s.

In new research, IMF economists attribute this resilience to five underlying factors:

1. Stronger demand

The reason for the current price hikes differs from the past. Increases in the 1970s and 1980s were caused largely by sharp disruptions to world supply. In contrast, a prime reason for the increases since 2000 has been stronger-than-expected demand from emerging market economies.

The strong growth of emerging markets has benefited both them and the global economy: raising living standards and increasing their demand for products made abroad.

A side-effect of this may have been an increase in oil prices, but this has not derailed the benefits of increased growth.

2. Central bank policies

Central banks and economies have become more adept at dealing with price shocks. In the 1970s and 1980s, oil price rises triggered fears of inflation, and workers would try to protect themselves by demanding higher nominal wage increases. This had the effect of setting off wage-price spirals.

Now, greater awareness of the impact of high wage increases—including lost employment and reforms to labor markets—have led to more job-friendly wage setting. Central banks have become more adept at convincing workers that oil price increases will not feed through into inflation.

Today, headline inflation temporarily increases after an oil price increase, but nominal wages hardly respond. Workers have grown to expect this rise in headline inflation, and anticipate that it will be temporary.

Given the experience of the past, more recently many oil-importing economies with strong central banks have experienced little impact on core inflation and wage increases, despite oil price rises.

This has allowed central banks to be more supportive of promoting recovery in the economy after an oil price increase, rather than having to raise interest rates to dampen inflationary expectations.

3. Recycling the benefits of oil profits

The revenues from oil exports are flowing back to oil-importing economies. This helps bring down interest rates for households and...