The Effects of the New Energy Regime on Economic Capacity, Production and Prices

11’ HE quadrupling of OPEC oil prices in late 1973 and early 1974 had a profound and permanent impact on the U.S. economy. The initial impact was an explosion in the prices of most goods and services, as well as the longest and most severe decline in national output since the 1930s. The recession trough occurred over two years ago and the rate of inflation has fallen substantially since 1974. While the inflation rate remains quite high by historical standards, the primary focus of concern, at least in official circles, seems to have shifted toward the persistence of an unacceptably high unemployment rate and the associated loss of national output. More importantly, the mounting concern over the immediate problem posed by unemployment seems to have obscured the permanent effect of the energy price revision. The large increase in the price of energy in 1974 permanently reduced economic capacity, or the potential output of the U.S. economy, by four to five per~ cent. The productivity of existing capital and labor resources was sharply reduced. Policy discussions which fail to account for the permanence of these changes, especially in the face of persistent unemployment, contribute to an overstatement of the benefits to be obtained from a conventional policy of aggregate demand stimulus. In order to clarify the gains which may be expected from a stimulative economic policy and the accompanying inflation risks, it is useful to examine the impact of the energy price revision on prices, production and employment.1 To facilitate this discussion,