This paper studies the impact of oil shocks on the U.S. economy—and on the motor vehicle industry in particular—and re-examines whether the relationship has changed over time. We find remarkable stability in the response of aggregate real variables to oil shocks once we account for the extra costs imposed on the economy in the 1970s by price controls and a complex system of entitlements that led to some rationing and shortages. To investigate further why the response of real variables to oil shocks has not declined over time, we focus on the motor vehicle industry, which is considered the most important channel through which oil shocks affect the economy. We find that, contrary to common perceptions, the share of motor vehicles in total U.S. goods production has shown little decline over time. Moreover, within the motor vehicle industry, the effects of oil shocks on the mix of vehicle sold and on capacity utilization appear to have been proportional in recent decades to the effects observed in the 1970s.
Contrary to popular opinion and previous studies, the U. S. economy is as sensitive to increases in the cost of oil today as it was during the oil embargoes of the 1970s, according to Valerie Ramey and Daniel Vine. Writing in Oil, Automobiles, and the U.S. Economy: How Much Have Things Really Changed? , they argue that earlier work on oil shocks underestimated the increase in the true cost of oil in the 1970s, when price controls and a complex system of entitlements led to long gas lines and outright rationing. "When we measure oil shocks as either the shocks to the price of gasoline adjusted for the cost of shortages or as the shocks to consumer sentiment toward gasoline, we find that the impact of these shocks on real activity has either diminished only slightly or has become larger in the later period," they conclude.
A major reason the United States is thought to be less vulnerable to oil shocks today is that although the last two run-ups in real gasoline prices -- during 1999-2001 and 2002-8 -- were larger than the first two run-ups during the oil embargoes of the 1970s, they didn't seem to have as much of an impact on the U.S. economy. However, the price controls and other government policies imposed during these periods added an additional but unmeasured cost on the economy. For example, the economic cost of waiting in gas lines added between 8 and 67 percent to the price of a gallon of gasoline in July 1979 and March 1974, respectively. Once those effects are factored in, the magnitudes of the first two oil shocks rival the last two.
Changes in consumer sentiment associated with oil shocks also have an impact on real economic activity, especially on sales of new cars, the authors find. Anxiety about high gas prices abruptly shifts consumer demand away from large gas-guzzling vehicles and toward smaller, more fuel-efficient vehicles. Because automakers can’t shift their production as quickly as consumers shift their demand, dealers are stuck with too many gas-guzzlers and not enough fuel-efficient models.
Using detailed data on auto sales and production, Ramey and Vine show that the mismatches between supply and demand for automobiles by car size were as large in the 2000s as they were in the 1970s and 1980s. They present evidence that the recent increases in gasoline prices have caused just as much anxiety among consumers now as the price increases 30 years ago did, and that the shifts in demand across vehicle size classes have been as disruptive to motor vehicle capacity utilization since 2000 as they were in the 1970s and early 1980s. Finally, Ramey and Vine find that the entire domestic auto industry’s share of total goods produced has not declined substantially since the 1970s.
