Why Do Oil Shocks Matter? The Role of Inter-Industry Linkages
View Journal ArticleThere is considerable empirical evidence that oil prices had a large effect on the U.S. economy from World War II until the 1980s. This paper argues that linkages between manufacturing industries play an important role in amplifying oil price shocks. I quantify the importance of demand and supply linkages by decomposing changes in industry-level value added into three sources. First is the direct effect: an increase in the price of oil raises costs in energy intensive industries. Second is the supply effect: an industry that uses energy intensive inputs experiences a large increase in materials prices after an oil shock. The third effect is the demand effect: an industry that supplies its output to energy intensive industries will see a large decrease in the demand for its product. Using data from the Census of Manufactures from 1963-1982, I find that the supply and direct effects explain a significant amount of variation in industry-level value added; the demand effect is relatively weak. The supply effect accounts for more than half the sensitivity of value added to the price of oil. Oil shocks appear to primarily affect average production per plant. The direct and supply effects cause similar changes in value added per plant as in value added per industry. A price increase causes a small, though precisely estimated, decrease in entry, and has no effect on exit. Thus, most of the effect of an oil shock is to decrease plants’ production levels.
