All but one of the U.S. recessions since World War II have been preceded by a dramatic increase
in crude petroleum prices. Recent turbulence in energy markets has some analysts speculating that,
in the immortal words of Yogi Berra, it could be deja vu all over again. But this oil price shock
differs significantly from earlier episodes, leading me to believe that the economy will be able to
adapt to the new pricing environment without a major economic slowdown.
|Date||Event|| Drop in world |
|Nov. 1956||Suez Crisis||10.1%|
|Nov. 1973||Arab-Israeli War||7.8%|
|Nov. 1978||Iranian Revolution||8.9%|
|Oct. 1980||Iran-Iraq War||7.2%|
|Aug. 1990||Persian Gulf War|| 8.8%|
In each of the five biggest previous oil shocks, there was a dramatic geopolitical event that
cut oil flows amounting to nearly 10% of total world oil production. For example, when Iraq
invaded Kuwait in August of 1990, oil shipments out of the countries, which between them had
previously been producing 5.3 million barrels a day, completely ceased. The price of West Texas
intermediate crude went from $18 in July 1990 to $36 in October, doubling in the space of three
This dramatic price spike led to abrupt changes in the patterns of spending on the part of U.S.
consumers and firms. For example, new car sales fell 17% between September 1990 and January 1991.
These changes in spending resulted in idle capacity and layoffs in key business sectors as the U.S.
went into its ninth postwar recession.
By contrast, global oil production has increased steadily during the current episode. The
run-up has been caused this time not by a shortage of supply but rather by booming world demand
(see What’s up with oil
prices?). The strong world economic growth that produced this demand overall must be regarded
as good economic news, not bad. And although we have again seen West Texas intermediate nearly
double from $28 in September 2003 to $54 today, this time the increase required a year and a half
rather than just three months.
Both the gradualness of the price move and the circumstances attending it have left consumers
and firms substantially less nervous about the current economic situation than they were in August
of 1990, with none of the postponing of spending decisions that characterizes most economic
downturns. U.S. car and light truck sales are only down 1% for the first five months of 2005
compared with the first five months of 2004, hardly enough to bring the auto sector to its knees, let alone the rest of the economy with
A shift in the composition of spending within the auto sector has also contributed to some of
the earlier recessions. If U.S. consumers suddenly buy fewer of the domestically produced gas
guzzlers and more of the fuel-efficient imports, domestic producers can be forced into layoffs.
But again, the shifts in the composition of spending underway right now have been much more
gradual. For example, sales of light trucks (which include the popular SUV’s) are down 2.8% in the
first five months of 2005, while sales of cars proper are up 1%. Domestic producer GM has taken a
somewhat bigger hit, with its light truck sales down 8%.
The U.S. economy certainly has the resilience to make gradual adjustments of this sort, which
of course are exactly what we need to do in order to respond to the reality that oil has become
more expensive to use. It is still possible that U.S. automakers will fumble this adjustment. The
weak financial status of the major airlines could also be a cause for concern about further
repercussions of high fuel costs. But, based on what is presently visible on the economic horizon,
my prediction is that this time we’ll manage to avoid this particular deja vu.
Detailed statistical analysis on which the above discussion is in part based is provided in my
paper “What Is An Oil Shock?”, published in the href="http://dss.ucsd.edu/~jhamilto/oil.pdf"> Journal of Econometrics in