Case Study: Oil and New Economy

You cannot get more old economy than to fret about the price of oil. Although the oil price is hard to miss when you come to refuel your car, economy watchers with any sophistication are encouraged at every turn to pay little attention. For instance, measures of "underlying" inflation exclude the oil price - too volatile, the argument goes, and no longer all that significant, one is led to suppose. Yet theory and empirical evidence suggest that the price of oil remains a fundamental driver of the business cycle. In all likelihood cheap oil has played a big role in creating the appearance of a "new economy" and dear oil, if the price stays up, may do more harm than many believe.
In Britain, the leading advocate of the view that oil still matters has been Andrew Oswald, a professor at Warwick University. In an article in the Financial Times last year he went so far as to claim that the so-called new paradigm is almost entirely an illusion caused by a prolonged period of extremely cheap oil. Now that the price has soared and assuming that it stays relatively high, he fears that the result will be a marked slowdown in the world economy.
Mr. Oswald is therefore a doubly unusual fellow: an easy-money new-economy sceptic. Most new-economy skeptics want monetary policy in the United States tightened faster (because they believe the surge in labor productivity will not last and that inflationary pressures are building). Mr. Oswald, in contrast, though a trenchant critic of the new economy, believes that monetary policy should be on recession watch in both Britain and America.
Mr. Oswald, along with Alan Carruth of the University of Kent and Mark Hooker of the Federal Reserve, published an article in 1998 which helps to makes the case for this view. The starting point is the chart, which repays careful study. The association between