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Thursday, August 10, 2006

Econoblog: Will Oil History Repeat Itself?

James Hamilton and Stephen Brown on how oil prices impact the economy:

Will Oil History Repeat Itself?, Econoblog, WSJ Online (free): ...Economic forecasters keep a close eye on gushing fuel prices, which preceded recessions in 1974, 1979 and 1990. But so far, the global economy has seemed to shrug off recent spikes in the price of a barrel of oil, which has more than doubled over the past three years.

The Online Journal asked energy economists James Hamilton, of the University of California, San Diego, and Stephen Brown, of the Federal Reserve Bank of Dallas, to discuss why high oil prices haven't choked off economic growth.

Here's some of the discussion, but there's a lot more if you click through to the (free) original:

James Hamilton writes: The price of oil has more than doubled in the last three years, going from $30 a barrel to now above $75. On previous occasions when we saw oil price moves of this magnitude, such as 1974, 1979 and 1990, the world economy went into a recession. What's different this time?

In my view, part of the answer has to do with the cause and timing of the oil shocks. In each of the previous episodes, oil prices made their move within the space of a few months and were caused by war-related cuts in oil production. By contrast, the current run-up has been a more gradual process...

The answer seems to be that, in those previous episodes, consumers and businesses didn't go about things as before but instead made some pretty abrupt changes in their spending patterns. ... A rapid drop in consumer confidence ... led to significant drops in spending for key sectors. Because workers and capital cannot immediately relocate, the result was unemployment and idle capacity, which greatly magnified the economic losses associated with the energy bill itself.

For the most part, those sudden shifts in spending haven't been seen this time around. ...

Stephen writes: I think James and I are mostly on the same page. Three things have me concerned about the economy's ability to continue to out distance the oil price increases.

1) Until recently, consumers continued to spend even as energy prices and energy bill rose. Much of that seems to have been financed by borrowing against home equity... With housing prices no longer as strong and interest rates rising, we are seeing anecdotal reports that overall consumer spending has become sensitive to rising fuel costs. ...

2) We are also beginning to see reallocation effects in the economy that are the result of higher energy prices -- not just globalization. For instance, sales of big vehicles are down while Toyota's profitability is at a record high. Shippers are shifting away from trucking to more fuel-efficient rail.

3) And as James notes, rising productivity pushing oil prices upward explains the situation very well for 2003-2004. The price increases in 2005 and 2006 seem to be better described as supply shocks, or at least, developments outside the U.S.

Some of these increases seem to be driven by fears of disruptions in a very tight market, as well as by actual disruptions, such as have resulted from civil strife in Nigeria, continuing production issues in Venezuela, conflict in Iraq, and pipeline problems in Alaska....

James writes: ... Stephen's point about home-equity borrowing raises another very important issue, which is the interaction between oil prices and other strains that may be hitting the economy. The oil price spike of the first Persian Gulf War in 1990 came at the same time that construction employment was already falling due to a weak housing market. Given that backdrop, crashing auto sales proved enough to tip the economy into a recession.

By contrast, the price spike associated with Katrina last fall came at a time when the housing market and construction employment were still booming. That strikes me as a very important reason why all we saw that time was slower but still positive GDP growth.

The situation at the moment is clearly quite different from where we were last fall. ... It wouldn't take much of a shock from any source to become a lot more pessimistic about that forecast.

And then there's the critical role of consumer psychology. ...

Stephen writes: ...Back-of-the-envelope calculations based on previous research suggests that the gains in oil prices that have occurred likely only shaved 0.5-0.8% off of annual GDP growth in 2005 and will have similar effects in 2006 and 2007. So, higher energy prices probably aren't the only factor driving the current slowdown. ...

    Posted by on Thursday, August 10, 2006 at 02:07 PM in Economics, Macroeconomics, Oil | Permalink  TrackBack (0)  Comments (2)


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