MarketNeutral
12th April 2010, 12:19 PM
Ten of the 11 recessions in the United States since World War II have been preceded by a sharp increase in the price of crude petroleum. Oil had been holding around $80/barrel over the last month, but traded as high as $87 last week, leading the Financial Times to ask whether oil could give the "kiss of death to recovery."
Americans buy a little less than 12 billion gallons of gasoline in a typical month. With gas prices now about a dollar per gallon higher than they were a year ago, that leaves consumers with $12 billion less to spend each month on other things than they had in January of 2009. On the other hand, the U.S. average gas price is still more than a dollar below its peak in July of 2008. Changes of this size can certainly provide a measurable drag or boost to consumer spending, but are not enough by themselves to cause a recession.
My view is that it is not just the level of consumer spending but also a sudden change in its composition that sometimes contributes to an economic recession. When oil price increases are sufficiently sudden and dramatic, we see abrupt drops in consumer sentiment, postponement of purchases of consumer durables, and important changes in the kinds of vehicles consumers buy. Because labor and capital can not costlessly shift out of the affected industries, the result is unemployment in those sectors which is an important additional factor bringing the economy down. UCSD Professor Valerie Ramey and Federal Reserve Economist Dan Vine have a very interesting new paper demonstrating how shifts in the demand for light vehicles contributed to the U.S. recession of 2007-2009 in a similar way to what we observed in earlier downturns.
If these spending shifts are indeed an important part of the transmission mechanism, we would expect the economy to respond to changes in oil prices according to a nonlinear relation. A rise in oil prices may induce some consumers to postpone purchasing a car, but a fall in oil prices does not lead them to go out and buy two new ones. Moreover, an oil price decline can induce some other sectoral adjustments such as layoffs for those who work in the oil industry. I've recently completed a paper reviewing some of the academic literature in which I conclude that the empirical evidence for a nonlinear response is pretty compelling.
So to return to the question posed at the beginning: $87 oil is certainly not helping the recovery. But I would be very surprised if it proves to be the kiss of death.
http://www.oilprice.com/article-do-rising-oil-prices-threaten-the-economic-recovery-269.html
Americans buy a little less than 12 billion gallons of gasoline in a typical month. With gas prices now about a dollar per gallon higher than they were a year ago, that leaves consumers with $12 billion less to spend each month on other things than they had in January of 2009. On the other hand, the U.S. average gas price is still more than a dollar below its peak in July of 2008. Changes of this size can certainly provide a measurable drag or boost to consumer spending, but are not enough by themselves to cause a recession.
My view is that it is not just the level of consumer spending but also a sudden change in its composition that sometimes contributes to an economic recession. When oil price increases are sufficiently sudden and dramatic, we see abrupt drops in consumer sentiment, postponement of purchases of consumer durables, and important changes in the kinds of vehicles consumers buy. Because labor and capital can not costlessly shift out of the affected industries, the result is unemployment in those sectors which is an important additional factor bringing the economy down. UCSD Professor Valerie Ramey and Federal Reserve Economist Dan Vine have a very interesting new paper demonstrating how shifts in the demand for light vehicles contributed to the U.S. recession of 2007-2009 in a similar way to what we observed in earlier downturns.
If these spending shifts are indeed an important part of the transmission mechanism, we would expect the economy to respond to changes in oil prices according to a nonlinear relation. A rise in oil prices may induce some consumers to postpone purchasing a car, but a fall in oil prices does not lead them to go out and buy two new ones. Moreover, an oil price decline can induce some other sectoral adjustments such as layoffs for those who work in the oil industry. I've recently completed a paper reviewing some of the academic literature in which I conclude that the empirical evidence for a nonlinear response is pretty compelling.
So to return to the question posed at the beginning: $87 oil is certainly not helping the recovery. But I would be very surprised if it proves to be the kiss of death.
http://www.oilprice.com/article-do-rising-oil-prices-threaten-the-economic-recovery-269.html