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ve OPEC revenues are $400 billion lower over the period 2001-2030 under a Restricted Middle East Investment Scenario, in which policies to limit the growth in production in that region lead to on average 20% higher prices, compared to the Reference Scenario.

Introduction

This paper reviews how oil prices affect the macro-economy and assesses quantitatively the extent to which the economies of OECD and developing countries remain vulnerable to a sustained period of higher oil prices. It summarizes the findings of a quantitative exercise carried out by the IEA in collaboration with the OECD Economics Department and with the assistance of the International Monetary Fund (IMF) Research Department. That work, which made use of the large-scale economic models of all three organizations, constitutes the most up-to-date analysis of the impact of higher oil prices on the global economy.

Oil prices have been creeping higher in recent months: the prices of Brent and WTI – the leading benchmark physical crude oils. These price increases and the possibility of further increases in the future have drawn attention again to the threat they pose to the global economy. The next section describes the general mechanism by which higher oil prices affect the global economy. This is followed by a quantitative assessment of the impact of a sustained rise in the oil price on, first, the OECD countries and then on the developing countries and transition economies. Finally the net effect on the global economy is summarized.

Oil Price and the Global Economy

Oil prices remain an important determinant of global economic performance. Overall, an oil-price increase leads to a transfer of income from importing to exporting countries through a shift in the terms of trade. The magnitude of the direct effect of a given price increase depends on the share of the cost of oil in national income, the degree of dependence on imported oil and the ability of end-users to reduce their consumption and switch away from oil.

It also depends on the extent to which gas prices rise in response to an oil-price increase, the gas-intensity of the economy and the impact of higher prices on other forms of energy that compete with or, in the case of electricity, are generated from oil and gas. Naturally, the bigger the oil-price increase and the longer higher prices are sustained, the bigger the macroeconomic impact.

For net oil-exporting countries, a price increase directly increases real national income through higher export earnings, though part of this gain would be later offset by losses from lower demand for exports generally due to the economic recession suffered by trading partners.

Adjustment effects, which result from real wage, price and structural rigidities in the economy, add to the direct income effect. Higher oil prices lead to inflation increased input costs, reduced non-oil demand and lower investment in net oil importing countries. Tax revenues fall and the budget deficit increases, due to rigidities in government expenditure, which drives interest rates up.

Because of resistance to real declines in wages, an oil price increase typically leads to upward pressure on nominal wage levels. Wage pressures together with reduced demand tend to lead to higher short term unemployment. These effects are greater the more ab