The linkage between oil price shocks and economic growth with inflation in the presence of technological advances: a CGE model

This study examines whether oil price shocks are inflationary in the US. We increase the price of oil in the year 2000 in a manner consistent with the oil price shock of 1973–74 and let the economy experience a Hicksian technological change. Then using a dynamic computable general equilibrium (CGE) model, we conduct our analyses under two separate cases: (1) regular economic growth, and (2) low economic growth. We also run three technological scenarios: (1) no technology change, (2) technological advances in the manufacturing and refining sectors, and (3) technological advances in the manufacturing, refining, chemical, and service sectors. The effects of these changes are analyzed over the next 20 years until the year 2020. Our results suggest that while a shock of the magnitude experienced in the 1970s will have a fairly severe effect on such things as gasoline and refinery prices, the aggregate price changes will be largely dissipated over time at the aggregate level. Furthermore, the aggregate level of prices (CPI and PPI) will fall over time as the level of technological advances rise under both growth scenarios. There are several reasons why we would obtain such results. First of all, the structure of the US economy has changed remarkably since the early 1970s. Rather than being a manufacturing based economy, the US is largely a service based economy today and hence it is more protected form raw materials shortages. Second, the economy has had a steady history of strong growth and the faster an economy grows the quicker disruptions to that economy are dissipated. Finally, our economy is experiencing rapid technological advances in information systems which have served to reduce costs and maintain output in a wide number of economic sectors.