Exchange Rate Experience Between the Oil Shocks, Megan Garcia; Jessica Hoffer

First Oil Shock and Its Effects War between Israel and Arab countries OPEC (Organization of Petroleum Exporting Countries – International Cartel with the largest oil producers – Imposed oil embargo

1974 By March 1974 oil prices soared to $12 a barrel from a previous $3. This slowed down consumption and investment leading to the recession Current accounts balance decreased Unemployment increased Increases in the price of petroleum products increased the oil price affecting wages

Stagflation Combinations of stagnating output and high inflation Two factors: – Increases in commodity prices – Expectations of inflation

Internal and External Balance Governments shifted to expansionary fiscal and monetary policies Monetary growth rates rose Current account deficit became a surplus and neared zero However oil importing developing countries stilled had a deficit

The Weak Dollar Unemployment remained high then dropped in 1978 – 6.0% from 8.3% in 1975 Germany and Japan adopt expansionary policies Current account pushed into a deficit

The Weak Dollar U.S. expansion Little confidence for investors New Federal Reserve Board Chairman, Paul A. Volcker, with experience in international financial affairs Tightening the economy provided a turnaround by 1979 Floating exchange rates deemed harmful

The Second Oil Shock Fall of the shah of Iran Oil prices increased from $13 to $32 in 1980 Leading to stagflation High inflation slower growth This time monetary growth restricted to offset the rise in inflation Saw little improvement only to lead into the deepest recession in 1981

Summary Lesson learned from both oil shocks is that floating exchange rates are favored However after 1981 it became uncertain how successful High U.S. budget deficits Increase in oil production and prices lead to a volatile market