Rising oil prices signal increased scarcity of energy which is a basic input to production. Consequently, output and productivity growth slow. The decline in productivity slows real wage growth and increases the unemployment rate at which inflation accelerates. Under a monetary policy that maintains a constant nominal GDP, the price level rises by the amount GDP falls. If consumers expect the rise in oil prices to be temporary, they will attempt to save less to smooth out their consumption, which will boost the interest rate.
Research shows a strong relationship between oil prices and the unemployment rate.
As shown in Figure 8, rising oil prices led increases in the unemployment rate in '70s, '80s, and early '90s. Unemployment declined with oil prices from 1982 through 1990 and in the late 1990s. Rising oil prices retard productivity growth and raise the rate of unemployment at which inflation accelerates. Lower oil prices stimulate productivity growth and lower the rate of unemployment at which inflation accelerates. Figure 9 shows oil prices and a 12-month moving average of inflation as measured by the consumer price index.