A Note on Oil Dependence and Economic Instability

We show that dependence on foreign energy can increase economic instability by raising the likelihood of equilibrium indeterminacy, hence making ‡uctuations driven by selfful…lling expectations easier to occur. This is demonstrated in a standard neoclassical growth model. Calibration exercises, based on the estimated share of imported energy in production for several countries, show that the degree of reliance on foreign energy for many countries can easily make an otherwise determinate and stable economy indeterminate and unstable. Keywords: Indeterminacy, Energy Imports, Externality, Returns to Scale, Sunspots, Self-Ful…lling Expectations. JEL Classi…cation: E13, E20, E30. This is a substantially shortened version of our working paper, "Oil Dependence and Economic Instability" (Federal Reserve Bank of St. Louis, 2006). We thank Karl Shell, Nicholas Kiefer, and an anonymous referee for comments. The usual disclaimer applies. Correspondence: Yi Wen, Research Division, Federal Reserve Bank of St. Louis, P.O. Box 442, St. Louis, MO 63166-0442, USA. Email: [email protected]