The correlation between oil prices and the business cycle has fallen substantially over the past 30 years. Oil intensity in particular – that is the amount of crude oil used per unit of output – is now only half the level seen in the 1970s in almost all industrial countries. This can be attributed to an increase in energy efficiency, a broadening of the energy mix and the build-up of own production facilities.
Oil prices and the business cycle: What has or has not changed
However, a new report by the economists of Allianz Group and Dresdner Bank come to the conclusion that, despite this development, the connection between the oil price and the business cycle is closer than the drop in oil intensity might suggest. The increased importance of financial markets and wealth effects in the industrial countries has given rise to an alternative transmission mechanism. While oil intensity has halved, the business cycle impact is down by only around 25 %.
Equities react extremely sensitively to the squeeze on corporate profit margins in the wake of rising oil prices. The drop in equities leads to lower investment and less consumption. Given the global links between financial markets this then also leads to a synchronization of the economic cycle among the industrial countries.