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The Relationship Between the Price of Oil and Unemployment in Sweden

Written by H. Mellquist, M. Femermo

Paper category

Bachelor Thesis

Subject

Economics

Year

2007

Abstract

Thesis: Oil price fluctuations before 1973 A lot of research has been done on oil prices and their impact on the macro economy. One of the first to study the relationship between changes in oil prices and the way they affect the macro economy was James D. Hamilton. In 1983, he wrote a paper on this issue using US data. From his empirical work, he found that there is a positive correlation between the rise of oil prices in the United States since World War II and the economic recession. Although he cannot say that rising oil prices are the sole cause of the recession, this correlation is statistically significant. He estimated that the U.S. economy fell into recession about 9 months after the oil price shock. In his paper, Hamilton proposed three different hypotheses to explain the correlation. -Hypothesis 1: Correlation represents historical coincidence; that is, the factors that really caused the economic recession happened almost simultaneously with the rise in oil prices. -Hypothesis 2: Correlation comes from endogenous explanatory variables; that is, there is actually a third set of effects that simultaneously caused oil prices to rise and decline. -Hypothesis 3: At least some economic recessions in the United States before 1973 were causally affected by the exogenous rise in crude oil prices (Hamilton, 1983, p.230). Hamilton (1983) used data from 1948-72 in his work on econometrics. According to his first hypothesis, he had to reject the original hypothesis that there is no relationship between rising oil prices and economic recession. So now he knows that since there is no evidence of any historical coincidence, there must be a systematic relationship. After he tested the second hypothesis, he determined that the third set of effects he considered did not exist, which may be the reason for the rise in oil prices and the subsequent economic recession. To test this hypothesis, he used six different macroeconomic variables; real gross national product, unemployment rate, implicit price deflator for non-agricultural business income, hourly wage (wage) per worker, import price, and currency supply. These variables, either individually or as a whole, have not shown any behavior that may cause oil prices to rise in this way. He studied these variables a year before the oil price shock. Since Hamilton rejected the first and second hypotheses, he obtained more evidence to support the third hypothesis that some of the economic recessions in 1948-72 were caused by rising oil prices. However, there is insufficient evidence to show that rising oil prices are a necessary or sufficient condition for economic recession. 2.3 Oil consumption The economic growth of populous countries such as China and India has put unprecedented pressure on oil demand. China and India consume 1.7 and 0.7 barrels of oil per person per day, while the US and Sweden consume 25 and 13 barrels per person, respectively. We expect average consumption in China and India to increase with growth, but if this happens, oil production will have to increase substantially. Of the 65 oil-producing countries, 54 are already at the peak of production, and the other 5 are expected to reach the peak in the next six years. It is estimated that total world production will reach its maximum in the next 20 years. Only in the Middle East can oil production be increased, but in order to keep prices at a high level, their goal is to produce at a uniform rate (Vetenskapliga argument i energidebatten, 1995). In the long run, there are oil substitutes that are planned to replace oil consumption. Some examples are wind power, solar power, tidal power, water power, methanol and ethanol (Energimyndigheten, 2003). The problem with substitutes today is that the price is too high compared to the price of oil. 2.4 Unemployment There are four types of unemployment: • Cyclical • Frictional • Seasonal • Structural. Cyclical unemployment varies with economic recession and expansion. It increases during recession and decreases during expansion. Frictional unemployment is unemployment that occurs due to normal labor mobility. People who leave and enter jobs and create and destroy jobs are part of frictional unemployment. This unemployment is permanent. Seasonal unemployment occurs due to changes in weather and other annual events from one season to another. If you are a ski teacher, you only work in the winter, and in the summer you will experience seasonal unemployment. The occurrence of structural unemployment is due to changes in technology or international competition. Some jobs disappear because of new technologies, so people need to find other jobs and sometimes need to improve their skills (Bade & Parkin, 2003). When unemployment includes only structural, seasonal and frictional unemployment, full employment will occur. When there is full employment, the unemployment rate is called the natural unemployment rate (Bade & Parkin, 2003). The calculated unemployment rate is the number of unemployed divided by the size of the labor force. 2.4.1 Unemployment benefits There are two ways in which unemployment benefits can increase the unemployment rate. First, allow a longer job search. Read Less