ben s bernanke : energy and the economy remarks by mr ben s bernanke, chairman of the board of governors of the us federal reserve system, before the economic club of chicago, chicago, 15 june 2006. * * * in my remarks today, i would like to discuss the relationship between energy markets and the economy. as i am certain all of you are aware, the steep increases in energy prices over the past several years have had significant consequences for households, businesses, and economic policy. at least since the time of the first oil shock in october 1973, economists have struggled to understand the ways that disturbances to the supply and demand balance in energy markets influence economic growth and inflation. at the most basic level, oil and natural gas are just primary commodities, like tin, rubber, or iron ore. yet energy commodities are special, in part because they are critical inputs to a very wide variety of production processes of modern economies. they provide the fuel that drives our transportation system, heats our homes and offices, and powers our factories. moreover, energy has an influence that is disproportionate to its share in real gross domestic product ( gdp ) largely because of our limited ability to adjust the amount of energy we use per unit of output over short periods of time. over longer periods, energy consumption can be altered more easily by, for example, adjusting the types of vehicles that we drive, the kind of homes that we build, and the variety of machines that we buy. those decisions, in turn, influence the growth and composition of the stock of capital and the productive capacity of the economy. over the past thirty - five years, the u. s. economy has experienced some wide swings in energy prices. the oil price increases of the 1970s were followed by price declines in the mid - 1980s and then a price spike in 1990, with numerous fluctuations since then. from the mid - 1980s until fairly recently, market participants tended to look through these price cycles and did not allow their longer - term expectations for oil prices to be greatly affected by short - run swings in spot prices. but beginning around 2003, futures prices began moving up roughly in line with the rise in spot prices. thus, unlike in earlier episodes, the significantly higher relative price of energy that we are now experiencing is expected to be relatively long lasting and thus will likely prompt more - significant adjustments by households and businesses over time. this higher relative price of energy poses many important questions for economists and policymakers. why

tripled from 2002 to 2004, but they actually fell a bit last year as production disruptions in a number of countries limited supply and as consumers in other countries competed for available cargoes. thus, natural gas prices are likely to remain elevated for at least the coming few years. it is possible, however, that within a decade new supplies from previously untapped areas of north america could boost available output here, while imports of lng will increase to more substantial levels as countries seek to bring their isolated natural gas reserves to market. given time, these developments could serve to lower natural gas prices in the united states significantly. nonetheless, because of the higher costs of producing these supplies relative to the traditional sources of natural gas, as well as the elevated cost of other energy sources such as oil, natural gas prices seem unlikely to return to the level of the 1990s. thus, the supply - demand fundamentals seem consistent with the view now taken by market participants that the days of persistently cheap oil and natural gas are likely behind us. the good news is that, in the longer run, we have options. i have already noted the scope for improvements in energy efficiency and increased conservation. considerable potential exists as well for substituting other energy sources for oil and natural gas, including coal, nuclear energy, and renewable sources such as bio - fuels and wind power. given enough time, market mechanisms are likely to increase energy supplies, including alternative energy sources, while simultaneously encouraging conservation and substitution away from oil and natural gas to other types of energy. economic and policy implications of increased energy prices what are the economic implications of the higher energy prices that we are experiencing? in the long run, higher energy prices are likely to reduce somewhat the productive capacity of the u. s. economy. that outcome would occur, for example, if high energy costs make businesses less willing to invest in new capital or cause some existing capital to become economically obsolete. all else being equal, these effects tend to restrain the growth of labor productivity, which in turn implies that real wages and profits will be lower than they otherwise would have been. also, the higher cost of imported oil is likely to adversely affect our terms of trade ; that is, americans will have to sell more goods and services abroad to pay for a given quantity of oil and other imports. for the medium term at least, the higher bill for oil imports will increase the u. s. current account deficit, implying a greater need for foreign financing. under the assumption