| Summary: | This paper surveys the literature on the relationship between oil prices and the macroeconomy in order to explain why high oil prices over the past three years do not appear to have led to a slow-down the world economy. It makes three arguments. First, that oil prices have never been as important as is popularly thought. Second, that the most important route through which oil prices affect output is monetary policy: when oil prices pass through to core inflation, monetary authorities raise interest rates, slowing growth. It is argued that the direct effect of high oil prices on output is relatively small and that the microeconomic mechanisms proposed in the literature are insufficient to explain the historical impact of oil prices. Based on the second argument, the third argument is that high oil prices have not reduced growth in the past three years because they no longer pass through to core inflation, so the monetary tightening previously seen in response to high oil prices is absent.
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