The Oil Shocks and Macroeconomic Adjustmen'f in the United States

Though 'supply-side economics' is politically ascendant in the United States, the relative importance of supply versus demand factors in r,x:ent U.S. macroeconomic history remains in strong dispute. The direct effects of the oil shocks on aggregate supply, for example, do not aI:,pear to have been severe, in sharp distinction to the experience of other OECD econoJaies. Real wages iin the U.S. fell to absorb the oil price increases a~d pre-ta~: profitability remained strong throughout the 1970s. Demand factors seem to be paramount in the recessions of 1973-75 and 1980. Supply faclor~; are of greater, and probably decisive importance for the miserable ploductivity growth since the mid-1970s, though :m ways that remain unclear. My focus in this retrospective glance will be on the oil shocks and their cyclical aftermath, and I will argue for the :relative importance of demand factors in these episodes. I return briefly to the productivity issue in the concl asion. In the broad outline, the U.S. macroeconomic response to tt,e two oil shocks was similar, though the magnitude of key effects differed, ccmpara*"/e da~:a op the two shocks are summarized in table 1. As is evidert, a sharp recession followed each shock. Th,,output decliJae in 197,$--75 was more severe and persistent than in 1979-80; in the first case, there is a sevenquarter span from peak to trough (1973:1V-1975:II) while in the latter recession the steep decfine lasted only one quarter (1980:II). In fact, since 1979: I, the economy has wobbled erratically with little net growth, instead of turning decisiw~'ly to a sustained recession as many lbrecasters predicted. The major indicators of the cycle, such as the GNP yap or the unemployment rate, confirm the deeper output decline in the first episode. With respect to wages and prices, the similarities are stronger. Both periods highlight the exlreme sluggishness in wage-setting behavior in the American economy. Indeed, from 1973 to 1980, the annual percentage increase in labor compensation was always between 7.6 and 9.9 percent. No other industrial economy displays such consistency. The first and second oil shocks themselves had little effect on the rate of walge change, with nominal compensation accelerating very slightly in both cas,~s (table IL