A rising world price of energy imposes a macroeconomic cost on the United States in two different ways. First, to the extent that energy is both an important input to production and a consumption good, with limited elasticities of substitution and demand, the economy's production and consumption possibilities are necessarily reduced as energy becomes more scarce. Thus, even if an expansionary monetary and fiscal policy were successful in pushing the economy close to its full capacity level, the resulting real national income would be lower than if energy prices had not increased and real GNP might be lower as well. An earlier version of this paper was presented at the CEPR Conference on Energy Prices, Inflation and Economic Activity, Cambridge, November 9, 1979. Work leading to this paper was supported by the Center for Energy Policy Research of the M.I.T. Energy Laboratory, and that support is gratefully acknowledged. In writing this paper, I benefited considerablyfrom conversations with and comments from Olivier Blanchard, Stanley Fischer, Benjamin Friedman, Robert Hall, Franco Modigliani, Robert Solow, and an anonymous referee.
