Business ReviewQ1 2007 21FBY KEITH SILLKeith Sillis a senior economist in the ResearchDepartment of the Philadelphia Fed. This article is available free of charge at: www.philadelphiafed.org/econ/br/index.html.The Macroeconomics of Oil ShocksDuring the first quarter of 2002, the price of crude oil averaged $19.67 per barrel. Four years later, in the first quarter of 2006, the average price of oil had risen to $63 per barrel. In-deed, the high price of oil may not be a short-lived phenomenon: Futures mar-kets indicate that investors expect the price of oil to remain above $70 per barrel through 2008. For the postwar U.S. economy, the data show a clear tendency for oil-price spikes to precede or various reasons, oil-price increases may lead to significant slowdowns in economic growth. Five of the last seven U.S. recessions were preceded by significant increases in the price of oil. In this article, Keith Sill examines the effect of changes in oil prices on U.S. economic activity, focusing on how runups in the price of oil can affect output growth and inflation. He also discusses the channels by which oil-price increases might affect the economy and the historical evidence on the relationship between oil prices, economic growth, and inflation.economic downturns. Though most of these episodes occurred at a time when oil’s share as an input into U.S.production was larger than it is today, there is still much debate about how oil prices affect the economy. How concerned should we be about the economic consequences of persistently high oil prices? Oil prices matter for the economy in several ways. Changes in oil prices directly affect transportation costs, heating bills, and the prices of goods made with petroleum products. Oil-price spikes induce greater uncertainty about the future, which may lead to firms’ and households’ delaying pur-chases and investments. Changes in oil prices also lead to reallocations of labor and capital between energy-intensive sectors of the economy and those that are not energy-intensive. For these reasons and others, oil-price increases may lead to significant slowdowns in economic growth. Inthe postwar U.S. data, the correlation between oil-price spikes and economic downturns is not perfect — some oil-price increases are not followed by recessions. But five of the last seven U.S. recessions were preceded by significant increases in the price of oil. The most recent rise in the price of oil has not led (at least not yet) to an economic recession, but history nonetheless suggests that oil prices are an important element in assessing the economy’s near-term prospects. OIL PRICESFrom the late 1940s to the early 1970s, the price of oil was very stable, moving up only slightly.