Oil Prices and Their Effect on Potential Output

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Abstract
Oil prices have fluctuated considerably in the last few years, with major effects on the economy. This paper describes some of the mechanisms by which these fluctuations produce changes in the long-run growth of the economy. In particular, it analyses the effect on productivity, capital stock and structural unemployment. The analysis suggests that a (permanent) increase in oil prices can significantly reduce potential output. From an economic policy point of view, this effect may be more marked when competition in the product markets is low or when wage indexation is high; thus, reforms aiming to increase competition and improve wage-setting mechanisms help to reduce the negative effects of higher oil prices on long-run economic growth.

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