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Thursday, January 04, 2007

The Sensitivity of the Economy to Rising Oil Prices

In this Economic Scene, Austan Goolsbee looks at how the sensitivity of the economy to increases in the price of oil has changed since the 1970s:

A Country Less Dependent on Oil Is Free to Make Other New Year’s Resolutions, by Austan Goolsbee, Economic Scene, NY Times: Well, another New Year’s Day has ..., no doubt, started another wave of resolutions to ... go on a diet. But after seeing gas prices pass $3 a gallon last year, hearing all the talk about global warming and having a bad feeling about all the bluster coming from the Iranian president, Mahmoud Ahmadinejad, a great many folks wish the economy would go on a diet, too, and stop using so much energy.

Some of the fear over energy and the economy ... resides in people old enough to remember some grimmer New Year’s Days. In 1973, OPEC imposed an oil embargo against the United States and Western Europe... New Year’s Day 1974 came in the middle of the first great energy crisis. Oil prices shot up with the embargo and the American economy collapsed into recession ..., our first stagflation.

New Year’s 1980 was even worse: the Iranian revolution, American hostages and oil prices pushing $40 a barrel. The second great energy crisis once again plunged the American economy into a recession coupled with high inflation.

Our past seems to show that when oil prices rise too much, our economy cannot grow. These lessons have been taken to heart by Mr. Ahmadinejad and Osama bin Laden as each has contemplated ways to cripple the American economy.

But ... much has changed since the wrenching days of the 1970s... The energy used for each dollar of gross domestic product in 1980 was almost 70 percent greater than it is today. While we have collectively wrung our hands over the decline of manufacturing in the country, it has also reduced the relationship between energy prices and growth.

Manufacturing industries consume about 25,000 B.T.U.’s of energy for each dollar of gross domestic product they generate. The most energy-intensive sectors, like the steel, iron ore and aluminum industries, consume about 70,000 B.T.U.’s. Outside of manufacturing, the economy uses less than 6,000. ...

So now when the price of oil goes up, ... it does not automatically mean recession. Indeed, it caused only a ripple this last year. Unemployment and inflation both stayed quite low. ... OPEC’s ability to impose an oil embargo on the West ... and bring the economy into recession is highly limited today.

Paradoxically, although the economy seems somewhat less prone to disruption from energy crises, there remains one enormous group that suffers from high prices: us, the car drivers. Industry has become less and less dependent on energy over time, but the average American commuter is now more dependent.

From 1980 to 1990, rising Corporate Average Fuel Efficiency standards forced automakers to improve car mileage significantly. .... That ended in 1990... Our regulations are now much less stringent than those in Europe, Japan and even China. We also shifted to driving trucks and sport utility vehicles. We moved farther from our places of work and drove a lot more. Since 1990, the number of gallons we use, even on a per vehicle basis, rose substantially.

So as the price of oil neared $80 a barrel last year and gasoline exceeded $3 a gallon, it did not bring the economy to its knees, the way previous oil crises did. It just hit all of us driving our cars. Mr. Ahmadinejad may not have the ability to terrorize the economy, but he can certainly aggravate soccer moms in their minivans or commuters stuck in traffic by making them pay more...

It is New Year’s so ...[f]orget about New Year’s resolutions for the economy and stick to your own. Next time you need to get somewhere, toss the keys and walk.

    Posted by on Thursday, January 4, 2007 at 03:45 AM in Economics, Oil | Permalink  TrackBack (0)  Comments (12)

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