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Oil Prices and the Economy

Although there is some uncertainty about the prices at which trading takes place on the oil market, there is no doubt that the falls in oil prices since the early part of this year amount to one of the most significant economic events of the 1980s. If falls of such magnitude are maintained, investment plans in the oil sector, and depletion policy, could be affected. Furthermore, other supply-side changes may be set in train, due to the relative price (of oil to other fuels) change, and switches in profitability from the oil sector to other sectors of the economy. There are other, more immediate and quantifiable effects of oil price changes however: on demand, on the exchange rate and on prices. In this note we will offer estimates of the second set of effects, abstracting from effects on North Sea oil investment, and from any effects that improved profitability of the non-oil sectors of the economy may exert on investment apart from those associated with the increase in macroeconomic activity. A ‘no change’ assumption for oil investment is made for convenience, and to ease comparison with other simulations reported subsequently in Section 3. As for investment in the non-oil sector, our econometric work has failed to detect an influence for company profits once full allowance is made for expected future sales by this sector.