Why might the relationship between oil prices and key macroeconomic variables have weakened?
Economists have offered some potential explanations behind the weakening link between oil prices and inflation. Gregory Mankiw (2007) suggests increases in energy efficiency as one explanation. Indeed, as shown in Figure 6, energy consumption per dollar of GDP has gone down steadily over time. This means that energy prices matter less today than they did in the past. Blanchard and Gali (2007) suggest additional explanations. They find that increased flexibility in labor markets, monetary policy improvements, and a bit of good luck (meaning the lack of concurrent adverse shocks) have also contributed to the decline of the impact of oil shocks on the economy. Finally, how monetary policymakers treated the economic shocks caused by rising oil prices also may have played a role in the impact of the shocks on economic growth and the inflation rate. Specifically, some have argued policymakers tended to worry more about output than inflation during the oil shocks of 1970s and did not adequate
