Very good post, but a few small points. If the oil price rise is caused by a war that reduces Saudi Arabia's ability to export, then the effect would be ambiguous. Price up, output down.
The effect of negative supply shocks on AD is often as you suggest, but in my view that's mostly because of inappropriate Fed responses. You can think of NGDP targeting as a policy of keeping AD stable when there is a supply shock, at least according to a simple definition of AD (total nominal spending on domestic output.)
Yes, on the Saudi. I'm assuming their production isn't affected, as the US is not in this case. On AD — agreed as a statement about optimal policy. I didn't want to get too much into that
But have you assumed in going from the penultimate equation to the final equation not just that there is no change in the cost of capital (which I could understand) but also that capital's share of cost is zero?
Great question! No, I'm not assuming S_K = 0. I'm assuming capital is elastically supplied in the long run. That comes because the real return to capital (r/P) is pinned by the world rate of return. So when the output price changes, the nominal return to capital moves one-for-one with it. In percentage changes: %Δr = %ΔP.
Start from the cost-share equation:
%ΔP = S_L · %Δw + S_K · %Δr + S_E · %ΔP_E
Substitute %Δr = %ΔP:
%ΔP = S_L · %Δw + S_K · %ΔP + S_E · %ΔP_E
Move the S_K · %ΔP term to the left:
(1 − S_K) · %ΔP = S_L · %Δw + S_E · %ΔP_E
Since S_L + S_K + S_E = 1, we have 1 − S_K = S_L + S_E:
The distributional question you raise is really important here. Even if net US oil production makes the aggregate GDP math work out, the consumer purchasing power hit and the tightening of financial conditions seems to be doing real damage as the Fed keeps rates steady. The global ripple effects, particularly for oil-importing emerging markets, look far more asymmetric than the domestic US picture. Worth reading alongside what central banks said this week: https://thisweekineconomics.substack.com/p/global-central-banks-lock-into-hawkish
Excellent post. I think one thing that might be missing from the analysis is the cost of Saudi Arabia vs the US to drill, refine, etc. petroleum into a product that that consumers can use. I believe that (historically, at least), it cost much less for Saudi Arabia to drill, refine, etc. it than it does the US. So Saudi Arabia has an incentive to keep oil prices below whatever threshold is needed to keep US producers out of the market and the recent price increase may disproportionately benefit the US over time. I don't know whether technological developments have changed this dynamic over time, but it is worth mentioning.
First, let me state that I am not an academic / economist. I am however a wealth manager.
I find this article interesting, but in practical implications for the economy, there is one data point that matters. That is: has the price of oil increased more than 80% over the past 12 months? If so, there is a near 100% predictive certainty of a recession under way or on it's way. WE ARE HERE TODAY. Couple that with the prospect of the 2/10 yield inverting and we are seriously going to be facing a recession if oil does not retreat soon. These two variables working in tandem are the best indicators I'm aware of for predicting recessions.
Oil doesn’t just move markets, it reshapes power. The question isn’t if it’s good or bad, it’s who is positioned to absorb the shock and who quietly benefits from it.
Very good post, but a few small points. If the oil price rise is caused by a war that reduces Saudi Arabia's ability to export, then the effect would be ambiguous. Price up, output down.
The effect of negative supply shocks on AD is often as you suggest, but in my view that's mostly because of inappropriate Fed responses. You can think of NGDP targeting as a policy of keeping AD stable when there is a supply shock, at least according to a simple definition of AD (total nominal spending on domestic output.)
Yes, on the Saudi. I'm assuming their production isn't affected, as the US is not in this case. On AD — agreed as a statement about optimal policy. I didn't want to get too much into that
Nice.
But have you assumed in going from the penultimate equation to the final equation not just that there is no change in the cost of capital (which I could understand) but also that capital's share of cost is zero?
Great question! No, I'm not assuming S_K = 0. I'm assuming capital is elastically supplied in the long run. That comes because the real return to capital (r/P) is pinned by the world rate of return. So when the output price changes, the nominal return to capital moves one-for-one with it. In percentage changes: %Δr = %ΔP.
Start from the cost-share equation:
%ΔP = S_L · %Δw + S_K · %Δr + S_E · %ΔP_E
Substitute %Δr = %ΔP:
%ΔP = S_L · %Δw + S_K · %ΔP + S_E · %ΔP_E
Move the S_K · %ΔP term to the left:
(1 − S_K) · %ΔP = S_L · %Δw + S_E · %ΔP_E
Since S_L + S_K + S_E = 1, we have 1 − S_K = S_L + S_E:
(S_L + S_E) · %ΔP = S_L · %Δw + S_E · %ΔP_E
Distribute the left side:
S_L · %ΔP + S_E · %ΔP = S_L · %Δw + S_E · %ΔP_E
Rearrange:
S_L · (%Δw − %ΔP) = −S_E · (%ΔP_E − %ΔP)
%Δw − %ΔP = −(S_E / S_L) · (%ΔP_E − %ΔP)
The distributional question you raise is really important here. Even if net US oil production makes the aggregate GDP math work out, the consumer purchasing power hit and the tightening of financial conditions seems to be doing real damage as the Fed keeps rates steady. The global ripple effects, particularly for oil-importing emerging markets, look far more asymmetric than the domestic US picture. Worth reading alongside what central banks said this week: https://thisweekineconomics.substack.com/p/global-central-banks-lock-into-hawkish
Excellent post. I think one thing that might be missing from the analysis is the cost of Saudi Arabia vs the US to drill, refine, etc. petroleum into a product that that consumers can use. I believe that (historically, at least), it cost much less for Saudi Arabia to drill, refine, etc. it than it does the US. So Saudi Arabia has an incentive to keep oil prices below whatever threshold is needed to keep US producers out of the market and the recent price increase may disproportionately benefit the US over time. I don't know whether technological developments have changed this dynamic over time, but it is worth mentioning.
Won't increased oil imports have the effect of increasing other exports and vice versa? Would seem to offset some of the national welfare loss/gain.
The military and secondary costs of war also worth mentioning? Their inclusion means US would have a net loss?
Please check my new article
https://substack.com/profile/484899886-samx/note/c-235090732?r=80p35a&utm_source=notes-share-action&utm_medium=web
First, let me state that I am not an academic / economist. I am however a wealth manager.
I find this article interesting, but in practical implications for the economy, there is one data point that matters. That is: has the price of oil increased more than 80% over the past 12 months? If so, there is a near 100% predictive certainty of a recession under way or on it's way. WE ARE HERE TODAY. Couple that with the prospect of the 2/10 yield inverting and we are seriously going to be facing a recession if oil does not retreat soon. These two variables working in tandem are the best indicators I'm aware of for predicting recessions.
Oil doesn’t just move markets, it reshapes power. The question isn’t if it’s good or bad, it’s who is positioned to absorb the shock and who quietly benefits from it.