New study of the effects of oil price shocks on the economy

University of Michigan Professor Lutz Kilian, whose research we’ve often highlighted here ([1], [2]), and Michigan Ph.D. candidate Paul Edelstein have an interesting new paper on how energy price changes affect the economy.

Edelstein and Kilian explored one implication of the popular idea that energy expenditures are relatively price-inelastic. If you go on purchasing the same amount of energy even though the price goes up, you have to cut back on other discretionary spending. The rough size of this effect would be given by the dollar magnitude of the loss in purchasing power. The authors sought to quantify this effect by calculating exactly how much consumers would have to decrease (or be able to increase) discretionary spending each month given how much energy prices went up (or down) that month, if they wanted to keep the quantity of energy used constant. In a typical month, energy prices might change by 1.5%, which would amount to a little less than 0.1% of total consumption spending. The biggest monthly shock in their sample (1970-2006) was associated with the aftermath of Hurricane Katrina, which reduced consumer purchasing power by -0.66%.

The authors then looked at the correlations between these measures of potential changes in discretionary spending and subsequent changes in various categories of actual consumption spending. Most previous studies had focused on output measures like GDP and had found asymmetric responses– energy price increases were often followed by slower GDP growth, whereas energy price decreases seemed to have little positive benefit. By contrast, Edelstein and Kilian found energy price declines are followed by higher consumption spending, just as price increases lead to consumption cutbacks.

However, like previous studies, Edelstein and Kilian found that the overall size of these effects, either up or down, is much bigger than can be explained by the discretionary spending story alone. The diagram below shows the average historical changes following an energy price increase that reduces purchasing power by about 0.1%. The horizontal axis measures the time (in months) after the initial energy price change, and the vertical axis measures the percentage change in the indicated category of real consumption spending. Ninety percent confidence intervals are indicated by dashed lines. The upper left panel indicates that even though potential spending has only decreased by 0.1%, consumption spending on average actually dropped by 0.23%.



Source: Edelstein and Kilian (2007).
edelstein1.gif



The other panels give a pretty clear signal of where the biggest effects are coming from– motor vehicle purchases change sharply and dramatically. Domestic car sales (which tend to be concentrated in the less fuel efficient models) were hit harder than foreign,



Source: Edelstein and Kilian (2007).
edelstein2.gif



and light trucks (which includes SUVs) much harder than autos:



Source: Edelstein and Kilian (2007).
edelstein3.gif



Consumers seem to be responding in a very direct and tangible way to the gasoline prices themselves.

Another strong effect that the authors found was on consumer sentiment. Even though a 1.5% increase in energy prices typically meant only a 0.1% drop in purchasing power, on average it was followed by a 1.6% drop in the University of Michigan index of consumer sentiment:



Source: Edelstein and Kilian (2007).
edelstein4.gif



All of this could be reconciled with rational behavior if one believed that car sales are important for aggregate economic activity. Because car sales indeed fall when gas prices go up, consumers rationally have increased worries about future job security when gas prices rise, and these insecurities are an additional factor in and of themselves inducing them to cut back on spending by even more than the direct impact on their wallets would require. Here’s what Edelstein and Kilian concluded:

Our results suggest that Hamilton (1988) was right that expenditures on consumer durables that
are complementary in use to energy (such as cars) are sensitive to even small energy price fluctuations.
We showed that indeed there is a strong decline in the real consumption of motor vehicles in
response to unanticipated purchasing power losses. This decline accounts for much of the anomalous
response of consumer durables and generates increased aggregate unemployment. However, there
is no evidence in the real consumption or consumer expectations data that changes in the demand
for vehicles cause a sectoral reallocation effect that amplifies the effect of energy price increases and
cushions the effect of energy price decreases, as postulated in Hamilton’s model.

That interpretation also led Edelstein and Kilian to draw some conclusions about why the economy may be less sensitive today to energy price increases than it had been historically. First, they noted that domestic automakers today have a better mix of large and small cars, so that some segments can continue to do well regardless of which way gasoline prices lurch. Second, with the increasing market share of imported cars and decreasing importance of manufacturing overall, the domestic auto sector matters less for the overall economy than it used to.

Nonetheless, as Econbrowser readers are well aware, that doesn’t stop me from worrying.



Technorati Tags: ,
,

40 thoughts on “New study of the effects of oil price shocks on the economy

  1. B.H.

    These results seem partial equilibrium.
    Suppose energy prices rise because of rising demand from rising population while supply did not change. Rising prices for consumer energy force consumers to trim spending on nonenergy consumption. Fair enough.
    But where does the revenue from higher energy prices go, and how is it used? In the US, all coal, most natural gas, one-third of crude oil, all nuclear, all solar, and most hydro are domestically produced and domestically owned. That means the income effect is largely a wash, unless we are talking about gasoline.
    At the general equilibrium level, we have to argue that a rise in energy prices results in a transfer of income which raises national or global savings. In effect, a backward shift in the “IS” curve, which hurts real GDP but also reduces the real interest rate.

  2. T.R. Elliott

    As a two hybrid family, we tend to watch cars a lot–particularly for Hummers, so we can mawk them amongst ourselves. My anecdotal observation: many many more small cars on the road here in San Diego. Exceedingly small cars. It’s starting to look like the streets of Paris. Not quite, but we’re on the way. I suspect this is a trend that will continue, making the Hummer and Escalade drivers look increasingly like the dinosaurs that they are.

  3. JDH

    B.H., the graphs here don’t make any assumptions about general or partial equilibrium, but just summarize the historical correlations– here’s what happened historically on average after energy prices changed. As for what those correlations mean, I disagree that we’re talking about a pure income transfer. When Hurricane Katrina knocked out several million barrels per day of crude oil production and refinery output, that was unambiguously a net loss of something valuable to the nation as a whole.

  4. Alex Khenkin

    In a typical month, energy prices might change by 1.5%, which would amount to a little less than 0.1% of total consumption spending.
    This ratio, 15 to 1, do the authors elaborate where it comes from? It seems to understate the loss of discretionary spending power in the world of mortgages that eat up 50+% of family income.
    Small Investor Chronicles

  5. JDH

    Alex, the data come from BEA PCE expenditures. The average share of energy in consumption is about 6.5%. You can see the plot of this series and how it changed over time in Figure 2 of the paper. The authors used a different value for this share each month as it changes.

  6. Alex Khenkin

    OK, and I see that they do compare it to overall expenditures, including food, housing, etc. However, overall expenditure is not the same as disposable income. One cannot (at least, easily) reduce the rent or mortgage, insurance, grocery bills, etc. The true discretionary spending share is smaller. Therefore, the 1.5% percent rise will, for many families, come directly out of their discretionary spending budget, while the better-off can simply reduce their saving rate and leave consumption unaffected.
    Small Investor Chronicles

  7. DickF

    We are entering an interesting time in economic analysis because the truth of the giants of economics are slipping away from our knowldge. It has been said that Ronald Reagan may be the last president taught classical economics.
    Because of the nature of their study Kilian and Edelstein are locked into analysis under a floating dollar regime. Data today is more and more unreliable on a comparative basis because of the fluctuations of the dollar. While analysts attempt to adjust for the fluctuations of inflation and deflation the tools they use, GDP, CPI, PPI, etc. are also seriously flawed because of the same monetary effects.
    If the underlying cause of the oil price shocks were monetary it would make sense that such things as auto sales would also be effected by the monetary instability so it should not be a surprise that they both rise and fall. Because of their relative sensitivity to injections of fiat currency it is also reasonable that they would rise and fall at different times though in the long run the effect would be basically the same.
    It is instructive to google “oil price history” to see that the oil price is relatively flat prior to the world being forced to a fiat currency, while after 1970 oil price fluctuations entered the whiplash area.
    The anguish over our reliance on foreign oil despots and our longing for energy independence were unheard of before the floating of the dollar. Oil has proven itself to be perhaps the most monetarily sensitive commodity today and so when inflation created OPEC and the energy crisis in the 1970s, then deflation pushed Texas into a Great Depression in the late 1980s, leading to shortages in the early 1990s and rising oil prices, until the deflation of the mid-1990s once again devastated the oil industry sending prices at or below the price of production, only to lead us into new energy shorages and the economic slowdown of 2000.
    The question of the relation of oil to auto sales will always be incomplete until the monetary mistakes of the fiat currency are built into the analysis but this is impossible to do accurately without reliance on a gold benchmark.
    If one doubts that the fiat currency has led us to a significant loss of wealth he only need compare real wages prior to 1970 to those since 1970.
    We fret over dusting the plates in the china shop while the real bull, the one conceived by Woodrow Wilson and given life by Richard Nixon, now resides at the Federal Reserve.

  8. T.R. Elliott

    DickF: You know the old saying: To the person with a hammer, every problem looks like a nail?
    When the Spanish found–read seized through slave labor–boat loads of gold from the new world, inflation was rampant. Why? Because they found a way to print money.
    Gold is an element. Nothing more. I’d rather a institution that manages monetary policy, not the luck of people finding elements in the ground and the popularity of artifacts like gold necklaces, teeth, and similar matters.
    The reason the 1970s are significant is simple: the US oil production peaked.
    It’s amusing to watch you tie everything into that one hammer you’re holding, but it’s not not true. Or should I say, it’s not significant.

  9. sam

    I was reading T.R. Elliot’s comment above that they mawk drivers of Hummers. At first I thought that he meant that they mock drivers of Hummers, and just got the spelling wrong, but then I checked on the definition of the word mawk. Turns out it is a word that means a maggot or a slattern. And it turns out that a slattern is an untidy, dirty woman. So today I learned that Hummer and Escalade drivers in San Diego consist of dinosaurs, maggots, and untidy, dirty women. The things you learn on the Internet.

  10. Charlie Stromeyer

    DickF, I believe that low real interest rates contribute to high real commodity prices. Why is it that globalization reduces the prices of imported goods (such as products made in China), but also increases the price of oil and other commodities?
    (Also, if uncounted intangibles are included in the standard sources-of-growth used by the BLS then it is found that labor’s share of income has been eroding significantly since the mid 1950s (which of course is before 1970). This is explained in this paper):
    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=877453

  11. T.R. Elliott

    Sam: Either San Diego Hummer drivers are as you say, or I need to check my spelling more frequently. I remember typing “mock” and then, for some odd reason, corrected it to “mawk.” Oops.

  12. DickF

    T.R. wrote:
    The reason the 1970s are significant is simple: the US oil production peaked.
    Not sure I understand you here. Known oil reserves have steadily increased since the 1800s. The efficiency of oil consuming machines has also steadily increased, yet oil consumption has also increased over this period of time. Can you give me a source for the peaking of US oil production in the 1970s?
    Gold is simply an element, a scarce element, difficult to consume, with more monetary qualities than any other commodity. It is this that makes it, not magic but, the best indicator of the change in value of money in the aggregate.
    Fiat money has destroyed economies for centuries; I would suggest you study John Law, the “inventor” of the fiat currency and how he destroyed the French economy in the early 1700s, the French assignats and the American Continental in the late 1700s, the US greenbacks created by Lincoln to “finance” the Civil War, the fantastic German inflation following WWI, and the South American currency disasters brought on by the world fiat currencies of the 1970s. Then study how Hamilton revived the US economy after the Revolutionary War and returned US currency to a sound footing and also study how the Bank of England kept the world monetary system sound during the 1800s facilitating world trade.
    Understand that it has been the nature of government to debase currencies since money came into existence. The fiat currency simply makes this easier for them.
    We can never understand the impact nor deal with fiscal problems until we deal with the overwhelming distortions an unstable fiat currency has on the economy. Each fiscal change will create a distortion in the monetary system and changes in the monetary system will negate or amplify fiscal changes.

  13. DickF

    Charlie Stromeyer wrote:
    …if uncounted intangibles are included in the standard sources-of-growth used by the BLS then it is found that labor’s share of income has been eroding significantly since the mid 1950s (which of course is before 1970).
    Yes, Charlie, an excellent point. Under the Bretton Woods Agreements the world gave the US control of the world money supply, and before the ink was dry the US began to abuse its power. It is possible to inflate a currency even under a gold standard, but the gold standard ultimately forces an accounting for the mismanagement.
    It was dollar inflation that caused the decline in real income and it was dollar inflation that caused Richard Nixon to break the final tie with gold. Nixon and Arthur Burns faced a dilema. They could do the right thing and solve the monetary crisis, causing Nixon to lose the White House, or they could break with gold and get Nixon elected. Acting just as any normal politician would react they threw the economy to the winds to win the election.
    Now to give them some credit, economic theory was so confused during this time that they could justify any action they wanted to follow and be supported by a host of economic experts, but records show that Burns knew what he was doing and did it anyway.
    The predictions were that once on a fiat currency the price of gold would actually decline because it would no longer have its primary use as money. After all this is what happend to silver when the bimetalic standard became a gold standard. Wrong!!!! Gold took off like a rocket. While it was no longer considered money it was still a depository to retain wealth and the massively inflating dollar certainly needed a safe haven.
    I must give credit to more current FED chairmen, Volker, Greenspan, and Bernanke, because they have only allowed the inflation termite to eat a small portion of our economy, but history shows that massive inflation and a devastation of our economy are only a matter of time, and I believe it will be sooner rather than later. Why? The government has created unimagined market distortions in health care, social security, education, and other programs in general. In the end the politicians will not have the courage nor the voters the fortitude to bite the bullet and do the right thing. The final solution will be to use monetary whitewash to cover the problem until the rot becomes so great that the house comes crashing down.
    Sadly today economists are choosing to ignore the problem while perfecting the methods of applying the whitewash.

  14. T.R. Elliott

    DickF:
    1. US Peaking. Plenty of references. Start with
    http://en.wikipedia.org/wiki/Hubbert_peak.
    US peaked around 1970. At that point, OPEC (or what would become OPEC) had the power to define terms of trade, knowing the US could not increase production. This is not a monetary phenomenon. The monetary “hammer” does not fit this “nail.”
    2. Money supply. Fixing the medium of exchange in a growing economy to a fixed element makes no sense to me. As the size of the economy grows, the fixed gold supply leads to price instability.
    3. Depending upon when one invested, gold has been (a) a great investment or (b) a terrible investment. Gold bugs do not great investment managers make.
    4. Fiat money has its problems. But it’s not the hammer that explains all problems. Not close.
    5. There is no reason at this point to go into a long debate on monetary theory. In my case, I commented on it because, when JDH posts on peak oil or price shocks or whatever, that “golden hammer” comes out looking for “golden nails” to make everything right–or at least better–and I feel the need to at least say that it just isn’t so.

  15. Joseph Somsel

    Look at the flip side of their results and the title of this posting – dips in energy prices do not increase aggregrate economic growth.
    I take this to mean that in a cheap energy world and a free market economy, we are already using excess energy return as fast as we can. The limiting factor (until peak oil hits) has been the infrastructure investment and government policies (aka interference) that constrain growth, not the energy resource itself since it has had such a positive EROEI.
    Russia is an example. Since the 50’s their economic and political system has been their constraint on economic growth, not limits on energy resources.
    When prices change, free people adjust. What a miracle!

  16. Businomics Blog

    Will Higher Gasoline Prices Sink the Economy?

    I’m choking on the high gas prices–not because I can’t afford them, because it seems so, so, . . ., expensive! The rational side of me says that it’s still a great bargain to be able to drive from home

  17. Alex Khenkin

    Russia is an example. Since the 50’s their economic and political system has been their constraint on economic growth, not limits on energy resources.
    Why the 50’s? Did it grow before and stop thereafter? What do you base this statement on?

  18. DickF

    T.R.
    From the wikipedia link you provided.
    In 1974, Hubbert projected that global oil production would peak in 1995 at 12-GB/yr “if current trends continue”.[4] However, in the late 1970s and early 1980s, global oil consumption actually dropped (due to the shift to energy efficient cars,[5] the shift to electricity and natural gas for heating,[6] etc), then rebounded to a lower level of growth in the mid 1980s (see chart on right). The shift to reduced consumption in these areas meant that the projection assumptions were not realized and, hence, oil production did not peak in 1995, and has climbed to more than double the rate initially projected.
    On money supply since you apparently do not understand that inflation is a monetary event I doubt any discussion will be fruitful.
    Generally gold is an awful investment. Gold does nothing but maintain its value against inflation or deflation. Gold is only a good “investment” when you have currency that is losing purchasing power, but it is only a good investment because it will prevent you from losing wealth. You would do best to invest in something that will produce and appreciate.
    The danger of fiat currency has been underestimated throughout monetary history, until historians look back with chagrin.

  19. DickF

    JDH wrote:
    DickF, I’ll be writing about the U.S. peak here next week.
    Thanks Professor. I look forward to the discussion.

  20. T.R. Elliott

    DickF:
    1. Why are you quoting Hubbert on world production predictions? We were discussing the fact of US peaking, which occurred around 1970. At that point, the US could only rely upon foreign sources of energy for continued economic growth. True, there has been demand destruction in the past, and will be in the future.
    2. I completely understand that inflation is a monetary phenomenon. I’m not sure of your point with this comment either.
    The dangers of fiat currencies are real. They are not the source of all the economic and geological issues discussed in this blog. Fiat currencies–and inflation–are in one sense, a form of tax, a distortion of the economic system. There are many distortions. The economy and its many features can be analyzed in a fiat system or a monetary system based on gold.
    Just to note: you’ve not addressed my issue with using a fixed supply of gold in a growing economy. How does one achieve monetary stability unless the gold supply grows at the rate of the economy? The answer: you don’t. At least that’s the way I understand. That, in and of itself, is a distortion, a deflationary one I believe.
    Finally, I do want to emphasize that I am trying to stay on point with the issues that you’ve raised. You’ve attributed a host of problems to fiat currency and it just isn’t true.

  21. Joseph Somsel

    My recollection was that the command and control economy of the USSR did experience rather high growth rates as it developed its infrastructure and then rebuilt it after WWII. The deStalinization effort released a good bit of energy too.
    By the time Breshev (sp?) was into his reign, growth slowed and stagnation came in. Political controls to stiffle dissent and free flowing vodka to lull the masses took its toll.
    By the time of Goby, economic growth was pathetic and he knew it.
    Of course, I know this only from the outside in reading popular accounts. Maybe that was too much Soviet propaganda. I’m sure a more scholarly approach based on the open archives would fill in the gaps and give us a more complete and accurate story.
    Anyone know a good source?
    Back to the first point of the posting. In the West, the exploitation of North Sea oil certainly boosted Northern Europe’s economies as did Cantrelle for Mexico. The freer economies of Europe did more with the bounty than did the PRI in Mexico.
    Maybe the conclusion is that long term cheaper energy helps but short term responses are slower.

  22. DickF

    T.R. wrote:
    …you’ve not addressed my issue with using a fixed supply of gold in a growing economy. How does one achieve monetary stability unless the gold supply grows at the rate of the economy? The answer: you don’t. At least that’s the way I understand. That, in and of itself, is a distortion, a deflationary one I believe.
    Sorry, from your earlier post I thought you didn’t want to get into a discussion of monetary policy so just quick response. Money is simply a medium of exchange. For example 122 yen does not function any better as money than 1 dollar simply because there are more of them.
    If we exchange $2 for a loaf of bread we expect the $2 to exchange for a comparable amount of other goods. Now if we add 2 million people to our population it does not change the fact that we have $2 that we expect to exchange for a loaf of bread. If tomorrow the baker will not exchange his loaf of bread for our $2 we have lost value by holding the $2 regardless of the population. Oversimplified this is the destruction of inflation.
    The fixed supply of gold forces the monetary authorities to keep that dollar within the $2 to one loaf of bread range. Concerning oil if the producers see their product falling like a rock in value relative to gold they will naturally raise the price of their oil. Analysis shows that the real price of oil today is still below the real price of oil in the 1960s, so OPEC, even with their price schemes, has failed to counter the effects of inflation.

  23. T.R. Elliott

    DickF: We’re off in the weeds at this point (as the saying goes), and I don’t want to detract from JDH’s main points. But you’ve not addressed the issue at all. I understand the basics inflation and monetary theory. I’ll stand corrected if an economist thinks I’m wrong, but gold (or any other token) is subject to the laws of supply and demand. The supplies of gold do not match the demand of a growing economy, therefore the example you give is wrong. A fixed supply–or in the case of gold, a supply that might grow with demand and technology–does not match the growth or needs of the economy.
    I believe an economy that grows more rapidly than the gold supply results in a deflationary effect, causing the gold that purchased one loaf of bread to purchase more bread after a time.
    Therefore there is no monterary stability with gold. It’s just not true. It was proven wrong in the case of Spain and Europe when gold supplies suddenly increased (inflation), and it would be proven true in a growing world economy with imbalances between gold supply and the size of the economy (deflation).
    If an economist comes in to say I’m wrong, I’ll look at their arguments. I just want to make clear that when you provide basic examples of monetary theory or other matters, you’re not addressing the issue I’ve raised.

  24. DickF

    T.R.
    I believe an economy that grows more rapidly than the gold supply results in a deflationary effect, causing the gold that purchased one loaf of bread to purchase more bread after a time.
    By your definition of deflation you would say that computers have been in a deflation since they were invented. Improvements and innovations in production that produce more goods for the same price do not cause deflation, an appreciation of the monetary standard. There is a difference between price decreases and deflation.
    A naturally growing economy should see consistent price decreases not because of deflation, a change in the value of money, but because the economy is constantly increasing the production of goods at the same or a lower price. This is why inflation targets by the FED are actually inflationary.
    To see this better imagine that the FED had increased the money supply to keep the price of computers at the 1960 level. In such a situation the FED would be increasing the money supply to counter productivity improvements in the economy.
    Your example of the increase in gold in Europe because of the Spanish importation of New World gold does support my point. This was an increase in the money supply leading to inflation resulting in the destruction of wealth in Spain. It is the same as the FED injecting currency into our economy, gold being the Spanish currency.
    But this increase in gold supply was an anomaly. Generally the gold supply is the most stable of all commodities. Combine this with the other qualities of gold, and while it is not magic, it is far better than any other monetary standard. Consider that the supply of a fiat currency can be and has been increased significantly more than the Spanish example at the touch of a botton.

  25. DickF

    DickF wrote:
    The fixed supply of gold forces the monetary authorities to keep that dollar within the $2 to one loaf of bread range.
    Alex Khenkin wrote:
    No it does not. As the number of loaves grows, the fixed supply of gold will force the price of a loaf down. Obviously.
    The only way for the suply of bread to increase is to have some innovation or improvement in bread production. In such a situation the monetary standard does not decline, the supply of bread increases. This is good for the economy and is not deflation.
    See my response to T.R.

  26. Alex Khenkin

    The only way for the supply of bread to increase is to have some innovation or improvement in bread production.
    May I suggest that an increased population may also lead to an increase in the number of loaves produced, without innovations or improvements? And how would gold know to keep the price of the loaf at $2 if the number is increased through population growth as opposed to productivity gains? And what do we do with the “monetary authorities” who fail to keep the dollar “within the $2 per loaf range” despite gold somehow “forcing” them to, even though we just established that gold cannot force the price to stay fixed?
    Small Investor Chronicles

  27. DickF

    Alex Khenkin wrote:
    May I suggest that an increased population may also lead to an increase in the number of loaves produced, without innovations or improvements?
    Sure, but you would still make no change in the monetary standard. Where are you going to get the labor and material to increase production? If you say unutilized capacity you have introduced another variable in our example, but even so, you are still not changing the monetary standard. To increase production you would need to trade leisure and material for bread production. Remember leisure is a commodity. If production techniques and systems remain the same there must be tradeoffs elsewhere in the economy. But there is no change to the monetary standard. There would simply be a shift in where the currency is used.

  28. Joseph Somsel

    For a historical example of gold vs bread, how about post-Civil War US?
    The gold standard was back big time (“sound money”), industrial productivity exploded, and farmers almost went into revolt (the populist movement) over falling ag prices.
    Seems to me that gold in circulation did not pace the overall economic growth and deflation resulted.

  29. T.R. Elliott

    DickF: No. Not computers. Bread. We were talking about bread. I get the feeling you are ignoring the basics of supply and demand, in particular supply and demand of a token such as gold–or whatever–when used as the means of exchange for the goods and services in a growing economy. If inflation is a monetary phenomenon–which it is–then deflation is as well, which would occur when the money supply doesn’t match a growing economy.
    You’re trying to have it both ways. Use inflation to support you golden position, but ignore the inherint deflation built into a fixed money supply like gold, so your argument is incoherent and deconstructs itself.
    At this points, let’s put it to rest. I believe monetary theory solved this problem long ago–and the answer isn’t the golden hammer. The fact that fiat money can be done wrong doesn’t make gold right. Fiat money is the right answer.

  30. DickF

    T.R.
    If inflation is a monetary phenomenon–which it is–then deflation is as well, which would occur when the money supply doesn’t match a growing economy.
    You are exactly right that deflation is a monetary phenomenon, but that means the appreciation of the monetary standard, not a change in technology, or production, or population.
    The period of the greenback during and after the Civil War is a great example of deflation. The fiat greenback was issued in 1861 and by 1862 the government suspended specie payments rather than return to sound money. Their intent was to inflate the currency so that they could buy military equipment without direct taxation (inflation is an indirect tax). Paper money fell in value against gold by 1-2% in the first year, but the government inflationary addiction continued and they issued so much currency that from 1861 to 1865 prices rose 117%.
    After the war Republicans resisted returning to sound money and inflation continued. The US credit rating was so low that few would purchase US bonds.
    In March 1869 President Grant finally signed the Public Credit Act to return government payments to a solid foundation, but Congress and President Grant did not understand that the extreme inflation changed the monetary standard so a sudden revaluation of the currency would create a serious deflation. The deflation from the return to the previous standard was the foundation for “Black Friday” in September 1869. Most of the serious problems from the deflation could have been avoided if the currency had been revalued closer to its inflated value somewhere around $50-75/oz.
    Many pretend that our current intoxication on a fiat currency is somehow different from past intoxications, but consider that this current binge is only a little over 30 years old. The first 10 years were the typical disaster, and, thankfully there was enough fear thrown into our monetary authorities that Volker, Greenspan, and now Bernanke returned to running the money supply on a defacto gold standard (though Greenspan was the only one who did it consciously). But even with this restraint we have experienced 68% inflation since 1980 with huge interim inflationary and deflationary swings.
    Back to the topic, US monetary policy has taken oil on a roller coaster ride swinging from $10/bbl in the mid-1990’s deflation up to $70/bbl in our current surge of inflation. You may not find anything wrong with such gyrations but I do recognize it leads to a significant destruction of wealth.

  31. DickF

    T.R. wrote:
    The fact that fiat money can be done wrong doesn’t make gold right. Fiat money is the right answer.
    I have given you significant incidences when a fiat currency destroyed economies. Please cite a time in history when a fiat currency has been done right.

  32. T.R. Elliott

    Alex: I’ve given up. Gold may be malleable but those obsessed by it become permanently fixed in their thinking.

  33. DickF

    Alex,
    Yes, there was deflation in the mid-1990s by your measure of price declines, oil being the prime example, and my measure of an appreciating monetary standard, the dollar exchage rate with gold being a prime example.
    Oil (SA Light) 1985 $29.00/bbl
    Oil (SA Light) 1989 $13.15/bbl
    Oil (SA Light) 1991 $20.00/bbl
    Oil (SA Light) 1999 $09.28/bbl
    Gold 1991 $362.11/oz
    Gold 1999 $278.98/oz
    Alex, I included 1985 and 1989 oil prices so that we could illustrate the deflation of the late 1980s since you mentioned it. I could go into more detail analyzing this for you but let it suffice to say that when Greenspan first became Chairman of the FED he kept the currency stable for almost 9 years. Then he stopped using gold as his guide and went to the Greenspan standard. The result was deflation (my definition of an appreciating monetary standard) starting about 1996 and running until 2000.

  34. yasser

    i am seeking history of growth of world economy and oecd econimies and oil tax effect into growth between 1999 to 2005 please send this topics into my email

Comments are closed.