Working Paper

Crude substitution: the cyclical dynamics of oil prices and the college premium

Abstract: Higher oil price shocks benefit unskilled workers relative to skilled workers: Over the business cycle, energy prices and the skill premium display a strong negative correlation. This correlation is robust to different detrending procedures. We construct and estimate a model economy with energy use and heterogeneous skills and study its business cycle implications, in particular the cyclical behavior of oil prices and the skill premium. In our model economy, the skill premium and the ratio of hours worked by skilled workers to hours worked by unskilled workers are both negatively correlated with oil prices over the business cycle. For the skill premium and energy prices to move in opposite directions, the key ingredient is the larger substitutability of capital for unskilled labor than for skilled labor. The negative correlation arises even when energy and capital are fairly good substitutes.

Bibliographic Information

Provider: Federal Reserve Bank of Atlanta

Part of Series: FRB Atlanta Working Paper

Publication Date: 2006

Number: 2006-14