Economists and policymakers alike have noticed the striking correlation between

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1 How Resilien Is he Modern Economy o Energy Price Shocks? RAJEEV DHAWAN AND KARSTEN JESKE Dhawan is he direcor of he Economic Forecasing Cener and an associae professor of managerial sciences a he J. Mack Robinson College of Business a Georgia Sae Universiy. Jeske is a research economis in he macropolicy secion of he Alana Fed s research deparmen and a visiing professor of economics a Emory Universiy. The auhors hank Thomas Cunningham, Pedro Silos, and Ellis Tallman for helpful commens. Economiss and policymakers alike have noiced he sriking correlaion beween energy prices and U.S. business cycles. Since 1973 every recession has been preceded by a rise in energy prices (see Figure 1). Conversely, almos every energy price hike has been followed by a recession. A large lieraure confirms his casual observaion of energy prices driving business cycles wih economeric mehods, including Rasche and Taom (1977), Hamilon (1983, 23), Roemberg and Woodford (1996), and Hamilon and Herrera (24). 1 Despie he empirical link beween energy prices and business cycles, he exising lieraure on dynamic sochasic general equilibrium (DSGE) models has eiher absraced from modeling energy or found lile effec of energy price shocks on he macroeconomy. Finn Kydland and Edward Presco, who are he pioneers of sudying business cycles in he DSGE framework, showed in heir seminal paper (Kydland and Presco 1982) ha a large share of business cycle flucuaions is accouned for by using one single exogenous shock, oal facor produciviy. Given ha hey had absraced from modeling energy use, Kim and Loungani (1992) add energy use on he firm side and a second exogenous shock, he energy price, o he Kydland and Presco framework. They confirm he original finding ha produciviy shocks sill explain a major porion of business cycle flucuaions. 2 Boh views ha of he DSGE-ype researchers who claim ha energy price shocks do no maer and ha of he empiriciss who claim ha hese shocks are he primary reason for business cycles in he Unied Saes are no enirely convincing. On he one hand, i mus have been a very unforunae coincidence for heoriss ha he weak produciviy observed in and occurred righ afer he energy price shock. On he oher hand, he empiriciss would have o address why in 1986, when energy prices declined sharply, we did no observe a major boom in he economy. Mork (1989), who invesigaed he 1986 anomaly, shows ha an asymmeric effec of energy price increases and decreases exiss: The fricions in he economy ECONOMIC REVIEW Third Quarer 26 21

2 Figure 1 Growh Raes and Energy Prices GDP year-over-year growh (percen) GDP year-over-year growh (percen) Real energy price (percen deviaion from mean) Real energy price (percen deviaion from mean) Noes: Recessions are indicaed by he verical bars. Recession daes are based on NBER business cycle daes. The real energy price is demeaned and based on he auhors' calculaions. Source: GDP growh raes from he Bureau of Economics Analysis (BEA); energy price daa from he BEA and he Energy Informaion Adminisraion cause a negaive effec on growh if energy prices go up bu provide no benefi when energy prices decline. 3 However, he empiriciss sill need o address why he recen run-up in energy prices has no caused a recession or even a slowdown so far. Real gross domesic produc (GDP) has grown a a solid 3.5 percen rae since he end of 22 whereas energy prices have risen by a magniude similar o ha observed in One poenial explanaion for his lack of energy effecs would be he low energy inensiy of he modern economy. For example, energy use measured in Briish hermal unis (BTU) per dollar of real GDP in 25 is abou half of he value observed in he 197s. Bu his share argumen is sill unsaisfacory: If he impac of an energy price shock is proporional o he energy inensiy, we should sill have observed half of he drop observed in he 197s, which cerainly would have made for a severe growh slowdown, if no a recession. I is difficul o characerize growh of 3.5 percen over he pas few years as being below rend by any meric. Who is righ he empiriciss who claim ha energy price hikes have srong and significan effecs on business cycles or he DSGE economiss who claim ha i is mosly produciviy ha maers? This aricle will reconcile he wo compeing views in he following manner. The DSGE-ype explanaion remains inac if we consruc a proper series for produciviy or Solow residuals by explicily aking ino accoun energy use in he producion funcion, which has been absen from sandard produciviy accouning exercises done before. In paricular, hese produciviy shocks coninue o be he prominen force behind business cycles. However, during he years 197 o 1985, produciviy iself was negaively affeced by energy price hikes. In he model consruced here, a Kim and Loungani ype economy, we allow for a negaive correlaion beween energy price shocks and produciviy based on our empirical evidence from 197 o This simulaion experimen confirms he findings of he economeric lieraure ha energy price shocks reduced real oupu 22 ECONOMIC REVIEW Third Quarer 26

3 growh prior o The correlaion beween energy price shocks and produciviy disappeared compleely afer Our model simulaion incorporaing his lack of correlaion explains why in 1986 here was no major increase in growh raes and, mos imporan, why here was no recession in 25. Therefore, we conclude ha he modern economy, represened by he period afer 1985, is very resilien o energy price increases. Consrucing he Model The model used here is based on a version of he DSGE model in Kim and Loungani (1992) ha incorporaes energy use on he firm side as well as a sochasic process for energy prices. Throughou he aricle, he erm energy price refers o he price of energy relaive o oher goods. The process for he price of energy P varies exogenously over ime. Specifically, we assume ha energy prices follow an auoregressive moving average (ARMA) process of he following form: (1) logp = ρ p logp 1 + ε p, + ρ ε ε p, 1, where he shocks ε p, are normally disribued wih mean zero and sandard deviaion σ p. This specificaion is sandard in he lieraure. 4 The model economy has a represenaive household ha obains uiliy from consuming C and disuiliy from working H hours. Specifically, we assume ha a any ime he household obains period uiliy, (2) u(c, H ) = ϕlogc + (1 ϕ)log(1 H ), where ϕ is he weigh he household pus on consumpion. Over ime he household discouns period uiliy a a consan rae β, wih < β < 1. Thus, he household maximizes expeced discouned uiliy: = ( ) (3) U E β u C H =,. The model economy also has a represenaive firm ha has hree inpus, labor H, he service flow from physical capial K, and energy E f. The firm purchases is energy inpu a relaive price P. We choose he following form for he producion funcion: ( ) 1 (4) Y = Z H α K + E η ψ 1 η ψ 1 f, α/ ψ, which is sandard in he lieraure (see Kim and Loungani 1992 and Dhawan and Jeske 26). Our funcional form implies ha he elasiciy of subsiuion beween capial and energy is 1/(1 ψ). Thus, if we choose ψ <, capial and energy will be 1. See Hamilon (25) for an exhausive lis of references. 2. Dhawan and Jeske (26) include household energy use and durable goods consumpion and confirm he Kim and Loungani resuls. Leduc and Sill (24) add moneary shocks and nominal wage and price rigidiies bu find ha energy price shocks sill do no play a major role. 3. Mork conjecures ha a model like Hamilon s (1988) can produce an asymmery in he energy price response. 4. The following secion will elaborae on he ime series properies of energy prices ha jusify his paricular funcional form. ECONOMIC REVIEW Third Quarer 26 23

4 complemens. In addiion, he firm is subjec o an exogenous produciviy shock Z, also called oal facor produciviy (TFP), as is he norm in he lieraure. Kydland and Presco s (1982) seminal research views business cycle flucuaions as he resul of movemens in TFP. We assume ha he Z evolves according o (5) logz = ρ z logz 1 + ε z,, where he shocks ε z, are normally disribued wih mean zero and sandard deviaion σ p. We do no include a consan erm because we assume ha he model is scaled in such a way as o make log produciviy equal o zero on average. We make a disincion beween he service flow of capial and he invesmen. The enire sock of capial K is used in he producion funcion while invesmen shows up in he naional income and produc accouns as he spending on new capial sock. The sock K and capial invesmen I k are relaed via he following equaion: (6) K = (1 δ k )K 1 + I k,, where δ k is he annual depreciaion rae of physical capial. To close he model we assume invesmen in fixed capial I k as well as consumpion C, and energy expendiures P E f are all financed by curren producion Y. The numerical echniques involved in solving he model are beyond he scope of his paper. We refer he ineresed reader o Dhawan and Jeske (26). Calibraion and Time Series Properies of Shocks The nex sep is o calibrae his model economy o mach daa measured a an annual frequency. Calibraion means maching he seady sae raios such as K/Y, I d /Y, hours worked H, and so on o he characerisics in he U.S. daa beween 197 and The specifics of he calibraion exercise are in Dhawan and Jeske (26), and he exercise produces he parameer values shown in Table 1. 6 An inegral par of his model is he calibraion of he shock processes. We now sudy some ime series properies of he wo shock processes for energy prices P and produciviy Z. This analysis will guide us in finding realisic specificaions of he shock processes used o simulae he dynamic model. We sar by esimaing a sochasic process for energy prices. The series for annual energy prices comes from he Energy Informaion Adminisraion (EIA). We ake he oal nominal energy spending (household plus firm level) and divide by he oal energy consumpion in BTUs o obain a series for he nominal energy price per uni of energy for We hen divide his series by he GDP deflaor o obain he real relaive energy price P. 7 Esimaing he ARMA(1,1) process in equaion (1) via he maximum likelihood mehod, we find ha (7) log P =. 8784log P + ε ε (9.6114) 1 p, (2.615) p,. 1 The -saisics are in parenheses below he poin esimaes, and ε p, has a sandard error of.753. Finding a saisically significan parameer esimae on he lagged shock (he moving average par of he ARMA) is consisen wih he findings in Kim and Loungani (1992) and Dhawan and Jeske (26), who also use an ARMA process for heir energy prices. One can show ha esimaing only an AR(1) process, hus dropping he regressor ε p, 1, generaes serially correlaed error erms. 24 ECONOMIC REVIEW Third Quarer 26

5 For his esimaed ARMA process, an Table 1 innovaion ε p of one sandard deviaion Calibraed Parameers would, all oher hings being equal, raise α.36 energy prices by 7.53 percen in he curren year and by 1.6 percen in he fol- β.966 ϕ.3382 lowing year before slowly decaying afer η.994 ha. The reason ha energy prices rise ψ.7 for wo periods in a row is ha he moving δ average erm ρ ε ε p, 1 also shocks nex period s energy price, and ha effec is k.656 sronger han he decay of he iniial shock. Anoher ingredien in he model is he sochasic process for produciviy Z. From he producion funcion above, we back ou he values of Z from he following equaion: (8) Y Z = 1 H ηk + ( 1 η) E 1 α ψ ψ α/ ψ f,, where we use he ime series for annual real GDP from he Bureau of Economic Analysis (BEA) for Y and he index for Nonfarm Business Secor: Hours of All Persons from he BLS for H. As a measure for he capial sock K, we use he BEA s esimae of he Ne Sock of Fixed Asses. Moreover, we subrac he BEA series for household nominal energy expendiures from he EIA oal nominal energy expendiures series. We hen divide by he price per BTU o compue real firm energy usage. Wih his measure we generae a ime series Z for produciviy from 197 o The essenial poins of his aricle will be made by emphasizing ha slighly differen formulaions of he produciviy process generae vasly differen resuls in he response of oupu o an energy price shock. We sar wih he mos basic specificaion in equaion (5), using Z as measured in equaion (8) and esimae i via ordinary leas squares o obain he following equaion: (9) log Z =. 883log Z +, ε ( ) 1 z, where he error erms ε z, have a sandard deviaion of Typically, when simulaing he model one assumes ha he innovaions o he wo shocks P and Z are independen. To check wheher his assumpion is adequae, we back ou he residuals necessary o generae he observed pahs for energy prices and produciviy. In specificaion A, he wo residuals display a sizable negaive correlaion of abou.5, as shown in Figure 2. Thus, he independence assumpion is clearly violaed, and feeding hese shock processes ino he model will miss an imporan link beween energy prices and produciviy. 5. For a formal exposiion of a calibraion process, see Cooley and Presco (1995). 6. This model corresponds o model E-I in Dhawan and Jeske (26), hough on an annual basis. We also performed a sensiiviy analysis along he energy share in he economy, which declined over he period. We find ha he numerical resuls are robus o his decline in energy share. 7. This is he series ploed in Figure This exercise also requires knowledge of he parameers α and ψ. We use he values as specified in he calibraion above. 9. Cooley and Presco (1995), using quarerly daa, find ρ z =.95, σ z =.7, which corresponds o ρ z =.81, σ z =.14 on an annual basis, almos idenical o our resuls. ECONOMIC REVIEW Third Quarer 26 25

6 Figure 2 Scaer Plo for Error Terms, ε z.1 Correlaion ε ρ Source: Auhors calculaions Wha is he source of he negaive correlaion beween shocks? To invesigae his quesion, we firs plo he error erms for he wo differen subsamples ( and ) in Figure 3. Noice ha in he pre-1985 subsample he wo error erms display an almos perfec negaive correlaion (.8618) while in he second subsample he correlaion is essenially zero (.39). Consequenly, we esimae anoher specificaion in which shocks in he energy price process are allowed also o spill over o he produciviy process. Specifically, we regress curren produciviy no jus on lagged produciviy bu also on he curren shock from he energy price equaion, muliplied by an indicaor variable for he years before In oher words, ε p, is included as an addiional regressor, which is he error from he price equaion imes an indicaor variable I( 1985): (1) log Z =. 8238log Z ε ( ) 1 ( ) I 1985 ε., z, p ( ) + According o our esimaes, he coefficien on he spillover erm is significanly negaive; ha is, a rise in energy prices was associaed wih lower produciviy before Even hough he coefficien may appear o be small in absolue value, he spillover effec from energy prices o produciviy is subsanial. To see his effec, consider he following example. A posiive innovaion o energy prices by one sandard deviaion reduces produciviy by abou 1.5 percen, or abou 1.76 imes a sandard deviaion of he produciviy shock. Thus, according o our esimaes, energy price shocks deermine mos of he flucuaions prior o A Discussion of he Resuls The model is simulaed by feeding in he shock processes for energy prices and TFP. Specifically, we perform experimens for wo alernaive specificaions of he TFP process. Specificaion A uses he esimaed process above wihou he correlaion erm while specificaion B includes he correlaion erm. The specificaions are as follows: 26 ECONOMIC REVIEW Third Quarer 26

7 Figure 3 Scaer Plo of Error Terms during Two Subsamples Correlaion.39 ε z.1 Correlaion.8618 ε z ε ρ Source: Auhors calculaions ε ρ.2 Specificaion A: log Z =. 8238log Z + ε (pos-1985); 1 z, Specificaion B: log Z =. 8238log Z. 1915ε + ε (pre-1985). 1 p, z, We hen repor impulse response funcions o an energy price shock over a ime horizon of fory years under he wo alernaive specificaions. The philosophy behind impulse response funcions is as follows. The model consruced earlier was calibraed o mach seady sae properies o hose observed in he daa. A he seady sae, all disurbances or shocks o he sysem are se o zero by definiion. From his equilibrium sae, he model is subjeced o a shock, in his case an energy price shock, and he model s response for key variables is racked over ime. 1 One can view his exercise as an economic laboraory experimen, sudying he response o one shock while swiching off all oher noise in he economy. We are primarily ineresed in he response of oupu o an energy price increase and herefore repor he oupu impulse response funcions o a posiive one-sandarddeviaion shock o energy prices. This shock ranslaes ino a 1.6 percen hike in he energy price. The op panel in Figure 4 displays he pah for he energy price following his one-ime shock. Noice ha because of he ARMA(1,1) srucure, he price increases for wo periods before i decays oward is old value in seady sae. The middle panel displays he effec on oal facor produciviy Z based on he wo alernaive specificaions, as deailed in he previous secion. Noice ha he impulse response for Z is enirely due o he energy price shock and no is own innovaion ε z,, which we se o zero along he ransiion pah. Therefore, TFP (Z ) says a zero for specificaion A, where energy price innovaions had no effec on produciviy. In 1. Technically, his procedure means ha one solves he firs-order condiions o find he decision rules using an appropriae numerical approximaion mehod. Ieraing over he decision rules when given a shock generaes he desired impulse response funcions. ECONOMIC REVIEW Third Quarer 26 27

8 Figure 4 A One-Time Posiive Energy Price Shock and Is Effec on Produciviy and Oupu for Two Differen Specificaions of he TFP Process 1 Energy price Percen 5 Percen Produciviy Specificaion A: Pos-1985 (wihou correlaion) Specificaion B: Pre-1985 (wih correlaion) Oupu Percen 1 2 Specificaion B: Pre-1985 (wih correlaion) Specificaion A: Pos-1985 (wihou correlaion) Time Source: Auhors calculaions specificaion B, however, produciviy drops dramaically because of he correlaion and is negaive implicaions on TFP, as described in he previous paragraph. The lower panel in Figure 4 plos he drop in oupu caused by his energy price hike. Noice ha he energy price hike does no cause any major oupu drop in specificaion A because here is no effec on he TFP process. The bigges drop occurs in he year afer he iniial energy price hike bu amouns o only a.43 percen drop in oupu before converging back o zero. This resul is consisen wih previous research showing ha DSGE models wih energy use do no produce major oupu flucuaions if energy price shocks are uncorrelaed wih TFP. 11 Under specificaion B, however, oupu drops by almos 2.4 percen. Even eigh years afer he shock, oupu is sill 1 percenage poin below he level where i would have been wihou he energy price shock. The echnical reason for his big and persisen effec is ha he energy price shock subsanially reduces TFP, which in urn affecs oupu. Recall from he calibraion secion ha for he period, a posiive one-sandard-deviaion shock o he energy price equaion, given he spillover effec, is equivalen o a 1.76 sandard-deviaion shock o TFP, which is big enough o drag down GDP subsanially. Hence, he impulse response funcion in specificaion A can be inerpreed as he oucome of energy price hikes in an economy se o mach daa characerisics afer 1985; similarly, specificaion B is for an economy wih characerisics from 197 o The fac ha energy price hikes were associaed wih major recessions in 1973 and 198, bu seemingly did no have any major oupu effec in he mos recen episode from 22 o 25, is hus enirely consisen wih our modeling srucure. 28 ECONOMIC REVIEW Third Quarer 26

9 Figure 5 Esimaed Sandardized Energy Price Shocks and Their Esimaed Marginal Effec on Growh Raes 2 Energy shocks (sandard deviaions) Sandard deviaion/percen 2 4 Marginal effec on growh (percen) Source: Auhors calculaions So wha do hese resuls mean in regard o he quesion posed in he aricle s ile? In he conex of our model, he economy oday is far more resilien o energy price hikes han i was before Even a major energy price hike caused by, say, a wo-sandard-deviaion shock o he energy price process in equaion (1) represens a drag of a mere.8 percenage poins in he second year of he impac in he modern era (defined as 1985 o 25). If he negaive correlaion observed in he 197s had prevailed, his price hike would have caused a precipious 4.8 percen drop in oupu. We can also use he model o deermine he marginal impac energy prices had on growh beween 197 and 25. In oher words, how have he observed energy price shocks beween 1971 and 25 affeced oupu growh in hese hiry-five years? To answer his quesion, we generae a oal impulse response funcion, ha is, no wih one single shock bu wih he hiry-five energy price shocks ε p, one afer he oher, as derived from our ARMA(1,1) esimaion. Consequenly, he impac of energy price changes in each year is he impac of he curren year shock in addiion o he impac from all lagged shocks. In his simulaion we assume ha specificaion B for he echnology process prevails, ha is, he pre-1985 era, when here is a negaive spillover from energy price shocks o he echnology. Afer 1985 echnology is unaffeced by energy prices because he indicaor variable in he regression equaion (1) is zero. Figure 5 plos he sandardized energy price shocks ε p, and heir marginal impac on oupu growh raes prediced by he model. 11. Specifically, Kim and Loungani (1992) show ha energy price shocks do no produce a sizable fracion of business cycle flucuaions. Dhawan and Jeske (26) show ha modeling durable goods on he household side even sofens he impac of energy price shocks because households have more margins o adjus heir behavior. Paricularly, households reduce new durable goods invesmen sharply o cushion he fall in fixed-capial invesmen, which miigaes fuure oupu losses. ECONOMIC REVIEW Third Quarer 26 29

10 Table 2 Growh Raes: Acual versus Counerfacual Acual (percen) Counerfacual (percen) a a For he counerfacual growh rae, energy price shocks affec TFP. Evidenly, energy price hikes had very adverse effecs on growh in 1974, 1979, and 198, knocking muliple percenage poins off oupu growh raes. For example, energy price shocks reduced oupu growh in 1974 by an esimaed 6.6 percen, meaning ha in he absence of energy price shocks, oupu growh would have been more han 6 percen insead of he acual.5 percen decline. Likewise, in he recession year 198, he acual oupu drop was.2 percen. The model simulaion reveals ha he growh rae ha year would have been 3.2 percenage poins higher, well ouside of recession erriory, if here had been no energy price shocks. Afer 1985, however, energy price shocks had a much smaller effec on oupu growh raes. The simulaion implies ha energy prices did no play any role in he 1991 and 21 recessions. The mos recen run-up in energy prices, while quie dramaic, wih hree posiive energy shocks in a row from 23 o 25, did no cause an obvious reducion in real GDP growh. The cumulaive impac of energy price shocks on 25 growh has been a mere.5 percenage poins. The energy shock in 198 (and 1979), abou equal in magniude o hose observed in 23 or 25, did far more damage, as discussed previously. We can also ask how much damage he energy price hike from 22 o 25 would have done had here sill been he same ype of negaive correlaion beween TFP and energy price shocks as observed in he daa before To answer his quesion we compue he marginal impac on oupu growh of energy price shocks, as discussed earlier, bu assume ha beginning in he year 23 he economy revers o he same shock process as observed in he pre-1985 era; namely, TFP is negaively affeced by energy price shocks ε p,. Table 2 repors growh raes for GDP for 23 hrough 25 under his scenario. The firs column is he acual growh rae as repored by he BEA. The second column is he growh rae under he assumpion ha TFP is negaively affeced by energy price shocks, he same way i had been before Had he TFP process been of he same srucure as before 1985, he recen energy price hikes would have dragged he economy ino recession boh in 23 and 25. Thus, he correlaion beween energy price shocks and TFP makes all he difference, and recessions would likely have occurred in 23 and 25, while wihou he correlaion, he economy showed resilience o energy price shocks. So far we have saed only saisical facs abou a spillover from energy price hikes ino reducion of TFP. We have no developed any heory abou he causes for a negaive correlaion beween echnology and energy price shocks before One can view his negaive correlaion as a reduced form represenaion for oher omied facors in he model. For example, Hamilon (1988) develops a model wih muliple secors in he presence of fricions for reallocaing producion inpus, primarily labor, beween secors. If energy prices have a differenial effec on secors, he economy has o spend a sizable amoun of resources o overcome hese fricions. This explanaion, of course, raises a quesion abou why hese fricions suddenly disappeared afer An alernaive explanaion for energy price hikes having vasly differenial effecs on growh in he wo subperiods is ha differen policies were in place o address he price hikes. Mos noably, he 197s were marked by price conrols on energy from 1973 o 1981 and wage conrols during he Nixon era. No surprisingly, during he oil 3 ECONOMIC REVIEW Third Quarer 26

11 shocks in boh 1973 and 1979, gasoline was raioned, while afer 1985 prices were allowed o move more freely. Evans (1982) sudies he impac of general price and wage conrols (no during he 197s bu during World War II) and finds ha hey caused a subsanial oupu loss. One can see how price conrols have negaive effecs on produciviy. In a marke wihou price conrols and any oher fricions, he price of a good like oil or a service like labor provides an efficien way of raioning scarce resources because he marke allocaes hem o he mos producive use. Specifically, only hose firms wih he highes produciviy are willing o hire workers and purchase energy a a given marke price. If, by conras, he price is no allowed o work as an allocaion mechanism, inpus may be used by inefficien firms. For example, if here are lines a he gas pumps, hose agens who are he mos paien or jus plain lucky ge he gasoline, while he mos producive agens may eiher ge no gasoline or wase precious ime and resources while waiing in line. This siuaion affecs businesses direcly if hey purchase gasoline bu also indirecly if i creaes uncerainy abou wheher employees arrive a work on ime. If he rules of supply and demand are suspended, hen idled resources and misallocaion of energy lead o less producive use of energy, which shows up as lower produciviy or TFP. If indeed all of he differenial impac on growh is due o price conrols, an implicaion from our model is ha price conrols no only harm oupu growh, bu heir indirec impac on growh (measured as he difference beween he impulse response funcions from specificaions A and B) is larger han he direc effec of energy price hikes (he impulse response funcion of specificaion A). Conclusions The general equilibrium analysis in his sudy shows ha energy price shocks can cause a large drop in oupu if and only if hey also affec he underlying produciviy (TFP) rend. Thus, oday s economy is very resilien because he TFP process is no being affeced by energy price shocks, as i was from 197 o Even he major energy price increases of 23 and 25, which are comparable in magniude o hose in 1974 and 1979, did no cause a recession as he underlying rend in TFP has been posiive since here were no negaive spillovers from energy prices o TFP like hose experienced before The aricle discusses ha a possible reason for his negaive correlaion was he energy price conrols observed in he 197s in response o energy price shocks. Thus, if he drop in TFP is due o a bad policy, hen he implicaion from our analysis is ha energy price shocks hemselves are far less damaging han he policies ha may be implemened o address hem. This is an example of he medicine likely doing more harm han he condiion i was supposed o cure. Do we believe ha he U.S. economy is shielded from any fuure recessions? Cerainly no! While he economy is more resilien o energy price shocks han before 1985, i is sill subjec o flucuaions in TFP unrelaed o energy price hikes. In addiion, if policies were o be implemened ha inhibi he funcioning of free markes, say, hrough price conrols or oher measures ha lead o energy raioning, he economy will again be suscepible o energy price induced recessions. 12. This figure is compued by firs subracing he marginal impac as repored in Figure 5 from he observed annual GDP growh raes, as repored by he BEA. This resul can be viewed as a model esimae for he growh rae ha would have prevailed in he absence of all energy price shocks. Then we add o ha number he marginal impac compued under he counerfacual assumpion of a negaive correlaion beween ε p, and TFP in ECONOMIC REVIEW Third Quarer 26 31

12 REFERENCES Cooley, Thomas F., and Edward C. Presco Economic growh and business cycles. In Froniers of business cycle research, edied by Thomas F. Cooley. Princeon, N.J.: Princeon Universiy Press. Dhawan, Rajeev, and Karsen Jeske. 26. Energy prices and he macroeconomy: The role of consumer durables. Federal Reserve Bank of Alana Working Paper 26-9, Augus. Evans, Paul The effecs of general price conrols in he Unied Saes during World War II. Journal of Poliical Economy 9, no. 5: Hamilon, James Oil and he macroeconomy since World War II. Journal of Poliical Economy 91, no. 2: A neoclassical model of unemploymen and he business cycle. Journal of Poliical Economy 96, no. 3: Wha is an oil shock? Journal of Economerics 113, no. 2: Oil and he macroeconomy. Universiy of California, San Diego, Deparmen of Economics, unpublished working paper. <hp://dss.ucsd.edu/ ~jhamilo/jdh_palgrave_oil.pdf> (Augus 23, 26). Hamilon, James, and Anna M. Herrera. 24. Oil shocks and aggregae macroeconomic behavior: The role of moneary policy: A commen. Journal of Money, Credi, and Banking 36, no. 2: Kim, In-Moo, and Prakash Loungani The role of energy in real business cycle models. Journal of Moneary Economics 29, no. 2: Kydland, Finn E., and Edward C. Presco Time o build and aggregae flucuaions. Economerica 5, no. 6: Leduc, Sylvain, and Keih Sill. 24. A quaniaive analysis of oil-price shocks, sysemaic moneary policy, and economic downurns. Journal of Moneary Economics 51, no.4: Mork, Knu Anon Oil and he macroeconomy when prices go up and down: An exension of Hamilon s resuls. Journal of Poliical Economy 97, no. 3: Rasche, Rober H., and John A. Taom The effecs of he new energy regime on economic capaciy, producion, and prices. Federal Reserve Bank of S. Louis Review 59 (May): Roemberg, Julio J., and Michael Woodford Imperfec compeiion and he effecs of energy price increases on economic aciviy. Journal of Money, Credi, and Banking 28, no. 4, par 1: ECONOMIC REVIEW Third Quarer 26