The check is in the mail

Falling gasoline prices will provide some stimulus to the economy. But how much?

Americans consumed 142 billion gallons of gasoline last year. That means that when gasoline prices rose $1/gallon last spring, if consumers and fuel-using businesses had not reduced the quantity of gas they purchased, they would have had to reduce other expenditures by $142 billion. That’s a bigger negative shock to spending power than the $90 billion that the federal government was trying to put back into consumers’ hands through last spring’s fiscal stimulus.

The run-up in gasoline prices hurt the economy not just by reducing consumers’ spending power. The abrupt drops in spending on key sectors of the economy exerted significant effects of their own. As higher gas prices caused consumers to shun Detroit’s gas guzzlers, U.S. production of motor vehicles and parts fell by 15% between 2007:Q4 and 2008:Q3 (BEA Table 1.5.6), subtracting an average of 0.6% from the annual GDP growth rate over the first three quarters of this year (BEA Table 1.5.2). The BLS reports that 135,000 fewer Americans were employed in motor vehicles and parts manufacturing in October 2008 compared with a year ago. And rocketing gasoline prices surely also contributed to plunging consumer confidence over the spring and summer.

Good news, though. The “cavalry has already arrived”, according to the WSJ. U.S. national retail gasoline prices are now down $2 a gallon from their height this summer, erasing the -$140 billion drain of last spring and adding net +$140 billion in disposable income for consumers and firms relative to where we stood one year ago.

U.S. average retail gasoline price. Source:

But it’s hard for me to believe that this is going to replace the negative developments of last spring and summer with a positive stimulus of the opposite sign. Those unemployed auto workers can’t expect to report back to work any time soon. And although falling gasoline prices brought a temporary revival to consumer sentiment in September, Americans are now weighed down by other concerns as the economic deterioration sets in. The Michigan/Reuters index of consumer sentiment was back down to 57.6 in October and barely improved to 57.9 in November.

Reuters/Michigan index of consumer sentiment. Data source: FRED and

Now that we’re in our current mess, the whole affair looks to many as if it had an air of inevitability from the beginning. That, however, is not my view. How severe the financial bankruptcies and mortgage defaults ultimately prove to be will depend directly on how far real estate prices decline. The magnitude of the price decline will be bigger the more severe a recession we experience. The economy was continuing to putter along with positive growth despite a dismal housing sector for two years. That by itself wasn’t enough to cause a recession. But when you put the depression in housing together with the negative effects of the oil price shock, it proved to be a potent combination.

My view is that we were teetering on the edge of a cliff last summer, and the oil price shock may have been just enough to tip us over the edge. As we did so, the financial disaster that had always been a potential became a reality.

The trouble is, now that the economy is in free fall, it’s going to take more than $2 gasoline to pull us back up.

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27 thoughts on “The check is in the mail

  1. Chris

    Falling oil prices are good news. It sure provides significant relief in a situation that would otherwise be desastrous. But now it is crucial how this free stimulus is spent. Unfortunately the message from the media and politicians is still: Consume, if you want to be good Americans! But in my view, people should be encouraged to use these funds for an orderly deleveraging process or true investments: pay down debt or for example buy insulation for their homes. Simply using it for consumption might well ease the current economic pain but will eventually make us weaker than ever, when oil prices will explode again.

  2. aaron

    I think the gas prices essentially caused the financial breakdown. When incomes didn’t rise and expenses when up, there was a big change in risk. I think it also lead to some very inefficient behavior. People accelerating too slowly and driving more during peak hours (squeezing in extra jobs and sales calls) to try to maitain income and driving less in off peak hours (for entertainment).
    Efficiency definitely has been going down since gas prices really started rising in 2005. Despite truck/suv sales declining and decreased driving which should lead to less congestion.
    I think the CBO made a big mistake is it’s assumptions that a gas tax would lead to the same increases in efficiency that CAFE would.

  3. satish

    gas prices are not falling because of increasing production but instead of decreasing demand. it is contracting economy that is causing oil prices to fall. demand fell by 7% yoy. worldwide oil surplus is n0w 3.5 mbd. if usa were to consume same amount of oil inturn keeping world economy humming it will make oil in to a deficit again.
    once the economy recovers it will be a short lived one causing oil prices to rise above 200 $ again. we are headed for turbulent times ahead.

  4. Strat

    What Satish said. The current drop in gasoline prices is due to a fall in demand. The blessing of cheaper gas is the sort of amelioration that always occurs as a system finds a new equilibrium after a shock. But it’s an amelioration, not a stimulus. If a gas price drop could the economy around, the rising economy would reverse the drop in demand for gasoline that caused its price to fall in the first place. So don’t expect the gas price decline to turn the economy around, because it can’t.

  5. Strat

    Sorry, left out a word:
    If a gas price drop could *turn* the economy around, the rising economy would reverse the drop in demand for gasoline that caused its price to fall in the first place.

  6. bill j

    I agree with JDH that it was the combination of the summer oil/raw materials price shock and the credit crunch following Lehman Bros that proved the final straws.
    Just one comment though, the slashing of oil prices will directly add $200/300bn to effective demand, but this increase will be consolidated by the general decline in raw materials prices, wheat, steel, copper etc.
    Therefore the impact on effective demand will be much larger than the oil figure alone.
    This is particularly important as for poorer “sub-prime” households, cheaper necessities, transport, food, clothes etc. may well make the difference between being able to keep your home and losing it.

  7. Anonymous

    Exactly what satish said. Oil prices lag consumer spending by about 12-14 months on 12-month rate of change curve. Oil prices are falling because the economy is slowing.
    And the cause of all of this is very simply the Federal Reserve, fiat money, the pumping up of debt in this country at all levels.

  8. Benign Brodwicz

    See link for an adaptation level theoretic explanation of consumer confidence. Confidence is doomed to a ying-yang alternation because of adaptation level effects. In particular, once the unemployment rate reaches a low that it will be difficult to go lower from, people get used to it, and small increases in unemployment torpedo confidence–until people get used to a higher level, and then small decreases from the higher level will increase confidence.

  9. Lee Adams

    A bailout that makes sense!
    I’m in favor of giving $85,000,000,000 to
    America in a ‘We Deserve It Dividend’. To make the
    math simple, let’s assume there are 200,000,000 bona
    fide U.S.Citizens 18+.
    Our population is about 301,000,000 +/- counting every
    man,woman and child. So 200,000,000 might be a fair stab at
    adults 18 and up. So divide 200 million adults 18+ into $85
    billion that equals $425,000.00.My plan is to give $425,000
    to every person 18+ as a ‘We Deserve ItDividend’.
    Of course, it would NOT be tax free. So let’s assume a
    tax rate of 30%. Every individual 18+ has to pay$127,500.00
    in taxes.
    That sends $25,500,000,000 right back to Uncle Sam.But it
    means that every adult 18+ has $297,500.00 in their pocket.
    A husband and wife has $595,000.00. What would you do with
    $297,500.00 to $595,000.00 in your family?
    Pay off your mortgage – housing crisis solved.
    Repay college loans – what a great boost to new grads
    Put away money for college – it’ll be there
    Save in a bank – create money to loan to entrepreneurs.
    Buy a new car – create jobsInvest in the market – capital
    drives growth
    Pay for your parent’s medical insurance – health care
    Enable Deadbeat Dads to come clean – or else
    Remember this is for every adult U S Citizen 18+ including
    the folks who lost their jobs at Lehman Brothers and every
    other company that is cutting back. And of course, for
    those serving in our Armed Forces. If we’re going to
    re-distribute wealth let’s really do it… instead of
    trickling out a puny $1000.00 ( ‘vote buy’ )
    economic incentive that is being proposed by one of our
    candidates for President.

  10. David Pearson

    Of course there are many who disagree that the current circumstances were difficult to predict.
    Start with a “meme” that Fed policy led first to a housing boom and then to commodity inflation
    Then throw in the impact of the “Fed Put”-induced great moderation” on risk perception and lending standards.
    Now use home-price-to-income as your principle metric for predicting house prices; and the efforts of emerging market Central Banks to curve inflation-producing reserve growth as a means of predicting commodity prices.
    To do the above, you have to believe that Fed policy was out of whack in 2002-2003. If you didn’t complain about 1% policy rates and their future impact then, chances are you didn’t predict their impact now. Its really that simple.
    Of course you will argue that economic forecasts are aligned on a bell curve, and we gloom-and-doomers were just lucky to be on the right tail. Maybe. But as they say on Wall Street, I’d rather be “lucky” than “smart”.

  11. aaron

    I don’t think it’s quite right that economic recovery will push gas prices back up near recent level. It shouldn’t, the rise in gas prices was based on unrealistic expectations of income. There was demand beyond reason due to bubbley activity. High expectation bled over to gas and oil prices. That new reality broke the assumptions people had when they made decisions, screwed up everyones models, and caused the crisis.

  12. Al Connelly

    Maybe a moderate drop in gas prices, your article would be supported, however, gas prices just tumbled my friend to levels unexpected by the market or the consumer.
    An estimated equivalency of $250Bill. in savings to the consumer. Nice tax break huh?
    Additionally, this is only one cog in the wheel of stimulus as the various “bailout” packages are just hitting main street now, as well as historic drops in Fed Funds rates. We may look back in a few years and ask ourselves, did we do too much?

  13. Mike

    Zeros matter when they are on the right side. I don’t think that $425 per adult would go very far to pay off a lot of mortgages.

  14. me

    Cheap oil today means exploration projects for tomorrow are cancelled or put on hold. All that does is increase the pain in another few years.

  15. satish

    price will rise depend upon the extent of recovery.
    if us economy achieves 4% growth then oil prices are ging to make new high. if confidence recovers then us economy will rocket given ultra low interest rates. i expect short fast recovery and them hyperinflation. economy may not shrink for 2-3 years and then world economy will crash with hyperinflation firmly gripping the world. us dollar may rise vs other currency but price rises around the world will be crazy.

  16. Strat

    Most people believe that the current decline in gasoline prices is caused by a decline in demand for petroleum, which is caused by falling income (and falling EM growth rates) due to the recession. If so, the decline in gasoline prices is a symptom of declining demand and therefore can not stimulate increased demand. Because the gas price decline is an endogenous result of the income decline, in other words, it can not counteract the income decline. Because it is a symptom of the recession, the bigger the gasoline price decline the worse the recession.
    The gas price decline then is a bad sign, not a good sign. It’s not like a tax cut, which would be exogenous.
    Am I missing something here?

  17. aaron

    We’ll know more in couple months. But I doubt the price decline is due to our consumption going down. I certainly haven’t been driving less. I think gas prices went up to take a share of the income that people thought they had due to asset price inflation.
    I think the prices have come down because people realize that they can’t stay in business if they, their employees, and customers have to pay so much for fuel. High costs and low return make things too risky. I think what you are missing is that the recession is due to the high price of the most basic and common input of all economic activity. Demand didn’t increase enough to justify a 100% increase in price over the last 2.5 years.

  18. Buzzcut

    How about gasoline at $1.69 a gallon? That’s what I paid in Tulsa yesterday.
    It was quite… refreshing.
    It’s $1.89 in the Indiana ‘burbs of Chicago.
    We’re blowing right through the $2 barrier.
    I can hear the SUV plants starting up as we speak.

  19. Zero X owner

    @ Buzzcut.
    Great on the SUVs. Worse mileage means more demand. More demand means the price will go back up. So the roller coaster will continue.
    A good reason to diversify away from only liquid fueled houehold transportation is to get away from that volatility (the current low prices should be as much of a red flag to you as the high prices a couple of months ago were). Start to substitute or feel the pain of high prices again later, over and over. How many times do we have to live through imported oil price shocks to understand that increased fuel efficiency and additional non-liquid, domestic energy cariers and fuel sources, for substitution, are good things for US consumers and the domestic economy?
    So long as it’s plug-in hybrid SUVs you hear being built in those re-started plants, we’re still making progess. Even if the mileage gains aren’t much, they exist over non-hybrids, and more electric drive and power packs means more and faster market penetration of efficiency and substitution away from imported oil, right?

  20. bena gyerek

    the weak oil price goes hand-in-hand with the strong dollar. the strong dollar is killing what remains of us manufacturing. it’s either the dollar or the us economy. i think i know which obama will opt for.

  21. calmo

    Nothin stops the gum chewin for me faster than the ordinarily careful, conservative JDH writing:
    “The trouble is, now that the economy is in free fall, it’s going to take more than $2 gasoline to pull us back up.”
    Ok, a miracle then…I cannot take any more anti-depressants according to the bottle.
    Last uplifting thing: bena thinks 1 person can change fx…and that will put US Exports back on the map…causing the free fall to rise like some big cake maybe.
    bena, thanks for the rescue effort, but do you have a grasp of the role that BoJ and PBoC have played in the past…and how that might change in the near future (bsetser…) owing to a depleted US consumer?

  22. don

    The saving in gas prices is not all boon to global demand – only the difference between marginal propensity to consume for the oil importers vrs. the oil exporters. The drop in oil prices is partly responsible for the drop off in U.S. exports.

  23. SG Hammer

    Equities are falling because companies are running out of working capital. The corporate markets are dysfunctional. Risk aversion by portfolio managers and investors has either eliminated demand or raised the cost of capital.
    One way to increase demand in the corporate markets would be to exempt corporate interest payments from some level of taxation. The amount and duration would need to be structured, but providing an incentive for participants to renter and start buying again is key to any solution. Maybe demand can be stimulated on an after tax basis and money would begin to flow again.

  24. lb

    SG, not a bad idea, but perhaps not helpful to long-term economic health until the deadwood gets cleared from the forest?

  25. Keith

    Professor – did you catch a gander at the PPI/CPI data yesterday? Even the beloved “core” CPI was negative, MoM. 2,5,and 30yr Treasuries today at record lows. When will the Keynesians admit they are wrong, that this massive money experiment is failing, and that you actually can’t “print” your way out of a deflation – because it is in reality more than just a monetary phenomenon? Does the year-over-year CPI number have to be negative first? Where’s the cutoff to reject your hypothesis 🙂

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