That’s the topic of the latest Wall Street Journal Econoblog, in which I was pleased to participate along with Stephen Brown, who is Director of Energy Economics and Microeconomic Policy Analysis at the Federal Reserve Bank of Dallas.
Here were my opening thoughts:
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 extended over several years, caused by surging world demand running up against limits to what global producers can supply.
One option available to an individual consumer or producer facing higher oil prices is just to go about business as before, saving or spending a little less on other items in order to pay the energy bill. The size of what you lose economically if you do that should be limited by the size of the increased energy bill itself. While painful, this is actually a fairly small number relative to the size of the GDP decline associated with an economic recession. One of the questions in explaining the recessions associated with earlier oil shocks is what accounted for that magnification of economic losses.
The answer seems to be that, in those previous episodes, consumers and businesses did not go about things as before, but instead made some pretty abrupt changes in their spending patterns. These showed up, for example, in a sudden big drop in U.S. sales of the larger, less fuel-efficient vehicles. A rapid drop in consumer confidence also 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 observed this time around. U.S. gasoline use has in fact continued to increase during the last three years, with the major manifestation of the higher oil prices being a decrease in the U.S. personal saving rate and increase in the extent to which Americans borrow from foreigners.
The point at which we came closest to a replay of the historical pattern was September of last year. Hurricane Katrina had a fairly dramatic effect on oil and gasoline supplies and prices, causing SUV sales and consumer sentiment to plunge. If auto sales had held steady, we would have seen healthy 3.3% growth in 2005:Q4 instead of the anemic 1.8% actually observed.
While I believe that episode had the potential to turn into an economic recession, in the event the disturbance to oil supplies was resolved more quickly than in earlier episodes such as the 1974 OAPEC oil embargo, the aftermath of the 1978 Iranian revolution, or the first Persian Gulf War in 1990. In 2005:Q4, oil prices came down as quickly as they had gone up, and consumer confidence was restored. That in my mind is a key reason why we’re not talking (yet) about the recession of 2006.
You can read the whole discussion at the Wall Street Journal’s free link, and add your own thoughts on these issues either in the comments section here or at the Wall Street Journal’s discussion board.