Will high oil prices bring a new recession?

Ten of the 11 recessions in the United States since World War II have been preceded by an increase in oil prices. Does the recent surge in oil prices mean we should be looking for recession number 12?

I’ve noted before that once energy expenditures get above 6% of average consumer spending, we start to see significant changes in spending patterns. We crossed that threshold in March, when 6.27% of every dollar spent went to energy-related goods and services. For lower-income groups, that expenditure share is significantly larger.

Energy expenditures as a percentage of consumer spending, 1959:M1-2011:M3. Calculated as 100 times nominal monthly consumption expenditures on energy goods and services divided by total personal consumption expenditures. Data source: BEA Table 2.3.5U. Blue line is drawn at 6.0%.

And you don’t need me to tell you that energy prices have surged dramatically since March.

San Diego Historical Gas Price Charts Provided by GasBuddy.com

A key sector for determining how the U.S. economy reacts is the auto industry. Let’s take a detailed look at what happened in the spring of 2008, which was the last time we saw gasoline prices like these. Because of strong seasonals, I like to summarize auto sales with graphs like the one below, which reports U.S. sales of imported cars. You can see what happened in an individual year by following a particular color horizontally, and can compare a given month with the same month in other years by looking at different colors. If you follow the dark blue bars corresponding to 2008, you’ll see that surging gasoline prices in the first half of 2008 were a boon for fuel-efficient imports, though these collapsed in the second half of 2008 as the recession became much more severe after the bankruptcy of Lehman in September 2008.

Data source: Wardsauto.com

On the other hand, as shown in the figure below, if you were a domestic manufacturer of light trucks (a category that includes larger sports-utility vehicles), those rising gasoline prices in the first half of 2008 were a disaster. There was a slight rebound in sales in August of 2008 when gas prices came down, but then the financial crisis delivered a second hammer blow to the industry.

Data source: Wardsauto.com

The struggling domestic auto industry was an important factor in the first year of the recession, which the National Bureau of Economic Research (not to mention Econbrowser as well) characterizes as having begun in 2007:Q4. I noted in a recent paper that if domestic U.S. auto production had not fallen, U.S. real GDP would have grown by 1.2% over 2007:Q4-2008:Q3.

The relevant concern at the moment is of course the light blue bars in the graph above, which report the data so far for 2011. It’s interesting to note that sales of domestically manufactured light trucks in April 2011 are not far from where they were in April 2008. But whereas in 2008, that level represented a significant decrease from previous levels, and thus contributed mechanically to a negative GDP growth rate, today they represent a significant increase from previous levels, and thus contribute mechanically to a positive GDP growth rate.

This discussion illustrates a principle that applies to the economy more broadly. Higher oil prices by themselves put a burden on consumers and force them to cut back spending somewhere. But getting unemployed people back to work is a much bigger positive factor in overall spending. The momentum of the ongoing recovery is an important factor that is serving at the moment to offset the contractionary effect of higher oil prices.

I’m also suggesting that, precisely because consumers never went back to the earlier spending patterns on items like bigger cars, $4 gasoline will not have the same disruptive effects now that it did when we experienced these prices for the first time in 2008. In a study I published in 2009, I noted that one could account for much of the overall decline in U.S. real GDP in the first year of the recession (that is, 2007:Q4-2008:Q3, prior to Lehman) on the basis of a relation I first published in 2003 (working paper version here). That simulation was based on a very nonlinear relation. The good news is that, high though current prices are, they actually would not trigger a response according to that relation because we are still below the highs reached less than 3 years ago.

I recently surveyed the academic literature on how strong the evidence is for this kind of nonlinearity. I personally find the evidence to be pretty convincing. However, a range of alternative nonlinear specifications fits the data equally well, many of which would begin to predict effects from the recent oil price run-up. My judgment is that, contrary to my 2003 model, there will be some contractionary consequences of recent developments, but, consistent with that model and many others, they will not be as severe as what we experienced in 2008.


41 thoughts on “Will high oil prices bring a new recession?

  1. Ivars

    Sure, Professor, looking straight into it. Recession q1 2012. Lasting 2 years, until the USA will find a way to default on the debts.

  2. aaron

    This is probably the best current analysis in existence.
    I’m slightly more pessimistic, I think we’ll see essential zero growth for a little more than half the year and maybe a little negative growth.
    I think the fall surge we had was an anomaly of thrift-burnout and an increase in families with children old enough to remember Christmas. Saving we cut into that need to be made up.
    The reaction of the markets was to bid up commodities and stocks. Investment in commodity production was minimal.
    Prices are too high for consumers and the profits investors have come to expect aren’t likely sustainable.

  3. aaron

    Based on disposable income minus the things people general consider not discretionary (food, gas, housing and utilities, healthcare), I don’t think people are better off than in 2008. Healthcare in particular has continued its rise, so I think people’s budgets are more fragile than in 2008. They are probably less willing and able to use debt to supplement their consumption.
    Gas price almost certainly won’t have quite as big an impact, since the people who are driving likely have sufficient disposable income. The margins have already been removed from the roads. I think prices will more likely prevent people from returning to the roads rather than they will push people off of them.
    It’s also simply time for some cars to be replaced.
    The increase in truck sales are quite encouraging. Those are people who actually do stuff that adds value, hopefully they aren’t over-extending themselves just to maintain capacity.

  4. Nemesis

    Look at the relationship of the rate of change of increase in oil consumption as a share of real per capita income, spending, non-residential spending, and GDP overall.
    In this context, the US/global business cycle peaked in Q1-Q3 ’10, and we are now at stall speed and decelerating, setting up contraction, only the delayed gov’t data won’t indicate it until the fall at the earliest, and perhaps not until early ’12 after the myriad benchmarks.
    Energy pass-through costs are already squeezing profit margins, which will cause annualized non-residential investment and production to markedly decelerate this summer-fall, along with an abrupt increase in jobless claims and decline in avg. employment growth hereafter.
    That the labor force is growing slowly, however, the upward effect on the U rate will be less pronounced until ’12; however, we are setting up the potential for a U rate of 14-15% (U-6 of 25%) in 20-24 months.
    Incremental US gov’t borrowing and spending hereafter will be entirely absorbed by increasing net interest costs and the increase in low- or no-multiplier personal transfer payments, including food stamps, U payments, and elder transfers, as well as additional bailouts of agency and student loan bad debts.
    With the US deficit already at 80%+ of federal receipts, there is effectively little further wiggle room left to increase spending and the deficit/receipts and /GDP.
    And the anticipated rebuilding of the post-tornado-demolished South will encounter slowing economic activity, fiscal constraints, and compassion fatigue, validating the broken window fallacy.

  5. Frank in midtown

    Very pessimistic crowd today. I would guess “no.” I’m voting on a greater price-elasticity than historically normal (due to the proximity of the last price shock.) The weekly petroleum report shows quite a bit of decline in yr/yr demand, so it looks like the cut in household spending will be on gasoline.
    ps While you may not consider light trucks to be fuel efficient, the new ones are likely more efficient than the replaced vehicles, and much more so than whatever ends up getting scrapped out at the end of the used vehicle market process. If we had access to the RL Polk vehicle data, I would expect we would see a shift within “light trucks” toward better mileage vehicles and heavy scrappage of gas hogs.

  6. Jonathan

    Thanks. I’ve been expecting this post.
    So the answer is maybe.
    Another difference is many jobs have already been lost and businesses have made some adaptions to survive with lower sales. Don’t know how long the 1/3 of small business that has been complaining about sales can go on, but the shock is not the same to them as when jobs evaporated, demand evaporated and credit evaporated.

  7. MarkS

    The FED and Congress appear to be fully committed to supplying endless liquidity to support consumption and the current payments system. There is no chance that a trifling detail like commodity inflation should retard America’s ability to spend more money.

  8. Ivars

    Real problem is, oil prices will move higher after a short dip they will experience now. Supply side has tremendous instability problems. It is only 3 months since MENA started, now OBL death is added, there are years to go until situation there somewhat settles , but right now it is ripe for further escalation.
    No supply=higher prices=new gloomier scenario.

  9. Steve

    I have been very consistent in saying we (U.S.) are not looking at a true recovery until late in 2013 or early 2014. The current administration has driven us off a cliff. By borrowing what will be nearly 7.0 trillion dollars, by passing Obamacare, by destroying domestic production of oil and by isolating us with a foreign policy that destroys our relationships with our historical friends, Obama and friends have made certain we will not be able to compete for years to come. The working and middle classes are in a depression! The housing bubble has destroyed all the working class jobs in construction and all the subsidiary business the home building industry brings. many people lost their businesses and homes. Now without jobs, unemployment comp gone and hungry children to feed, we will see people check out. Crime will rise, but they will need to do what is necessary to survive. The Country elected the equivalent of a religious zealot (one worlder)in 2008. He has done what he said he would do. He tripled the cost of energy and reduced U.S. power and standing in the world for the purpose of forcing the American People to agree to abandon our founding principles. The good news is he is already a failure, he just does not know it yet. 2012 will stop the bleeding. 2013 is a “Morning in America” moment and by 2014-5 we will be feeling the rebuilding process take hold. I can only hope Mr. Obama and all his thugs end up being brought to justice along with those who have robbed the People of their both their wealth and their spirit. Until Barak is gone, the American People are digging in to survive the siege on their Country and what is left of their wealth has been hidden for a better time to come. History will call this period the “Greatest Depression”! Make sure and look in on your neighbors now and then, it,s a rough world right now for millions of Americans.

  10. anonymous

    Nice to read/see a real economic discussion, one devoid of the political BS we constantly get in Menzie’s posts.

  11. aaron

    Frank, I’m quite certain (though haven’t tried to prove) that the theoretical improvement in vehicle efficiency is only that. I’m pretty sure the the increase in vehicle miles travel relative to gasoline consumption for the past several years is due to a coincidental bias, the drive to capture the big temporary increase in transit stimulus dollars.
    Such a big incentive doesn’t need a conspiracy, or even a conscious effort, to significantly affect data.
    I think the reality is that the effect on driving behavior decreased the overall efficiency of our roads more than mechanical improvements can make up.

  12. Menzie Chinn

    Anonymous (2:49 PM), aka Union Power aka Robert aka bob. If (in your Robert incarnation) you snicker about Macroeconomic Advisers, then I’m happy to be characterized as BS by you; it puts me in what I consider good company.

  13. Steven Kopits

    I would tend to agree with your conclusions. However, I think the economy’s response to continued oil price pressures needs to be assessed explicitly. Given the large budget deficit the country is running and the still weak state of the housing sector, the economy may be more fragile than anticipated.
    The Offshore Technology Conference ends here in Houston tomorrow. It is gargantuan event held in in Reliant Center and Arena, with thousands of exhibitors. It was well-attended by a crowd of 72,000. My two observations: there seemed to be more women, about 15-20% of the crowd in a one presentation this morning. (The crowd traditionally is mostly engineers and guys in polo shirts with with “Larry” emblazoned on the chest.)
    And the cars continue to get better. Austin Martins, kitted-out Porsches, plenty of BMWs. Houston is growing up fast.

  14. Steven Kopits

    From Platts:
    Analysis of US EIA data: US oil demand drops sharply for week ended April 29
    New York – May 4, 2011
    U.S. oil demand fell an eye-popping 1.256 million barrels per day (b/d) to 18.332 million b/d during the week ending April 29, with every product category declining except middle distillates, according to data released by the US Energy Information Administration (EIA) Wednesday.
    Of the 1.256 million b/d decline, “other oils” and/or petrochemical feedstock accounted for about 75% of the drop.
    At 18.332 million b/d, US oil demand was 1.135 million b/d less than year-ago levels.
    But on a four-week moving average, demand at 19.113 million b/d, was 265,000 b/d greater than the same time a year ago.
    Gasoline demand continued to act as a drag on the total figure. Demand on a four-week moving average, of 9.084 million b/d, was 178,000 b/d less than the same period a year ago.

    One week does not a recession make, but…wow.

  15. Jake M/

    I’m more concerned about the bubblicious nature that Wall Street has pumped into oil and other commodities. Sooner or later, that speculation will pop, and those ovepriced amounts will be driven down, along with the stock market.
    Steven K’s mention of reduced demand may not be much more than the weekend after Easter. In suuply/demand of gasoline in the real world (i.e, the one outside of Wall Street that actually uses oil and gas in vehicles), there is no supply disruption, and demand is under control.
    But I do think high oil/gas combined with fiscal contraction might mute what seemed to be an accelerating recovery in the earlier part of this year. Does it lead into full-fledged double-dip recession by the end of this year? I’ll go 60-40 against.

  16. benamery21

    Your analysis seems to be predicated on oil not rising further? Does that seem like a good bet?

  17. GK

    The unsophisticated childishness of the general public and financial media is stunning.
    Before QE2, people were whining that home prices were dropping and ‘their’ houses were underwater.
    During QE2, home prices stabilized but now they whine about food and oil.
    After QE2 ends, no doubt they will whine about housing again, with no mention of moderated oil prices.
    So do they want inflation or deflation? This notion that they can be selective about where they want inflation vs. deflation shows that the simplistic public deserves the hardship they are getting.

  18. river

    No qualifications on how high the gas price can go and your analysis is still valid? Anything over 6% of average consumer spending is “high gasoline,” well, what if it goes to 7% then to 8%? Is there some point when your analysis loses its validity?
    Also, back in 2008, mark-to-market accounting was still in effect, so people getting their budgets squeezed possibly lead to an increase in defaults, which would seem to add to banking crisis we experienced. Now, “luckily,” we don’t have that problem.
    Finally, how could gas prices at the same level as today hurt us so bad back in 2008, when our unemployment level was pretty good, but now has not as much effect two years later with unemployment so high and people’s budget’s so stressed? I would have expected a lower threshold for gas prices to kick in.

  19. Tord Steiro

    //My judgment is that, contrary to my 2003 model, there will be some contractionary consequences of recent developments, but, consistent with that model and many others, they will not be as severe as what we experienced in 2008.//
    Sure enough, however, oil-proces are not the only game in town. Governments around the world are tightening belts, reducing public demand. QE2 will be phased out in the near future. And who knows which other risks are lurking around the corners? Hurricanes? Earthquakes? Forest fires? War somewhere where it matters? Supply disruptions of important goods? A property crash in china? A new round of protectionism? Failed austerity measures? Nobody knows. And since high oil prices certainly don’t help, high oil prices increase the risk of recession regardless of their isolated impact.

  20. ppcm

    May be worth trying to confirm a status and read hereunder models
    The Fed model, where the level of spread is indicative of recession or change to come in the economy (note it is more coincident as time goes than leading).Still at zero percent probability)
    Iron man (US recession-probability track,political calculations).As usual, inflexible in his sciences ( 0% probability)
    The equities markets
    See, the earthworm moving its head up as of year end 2009, equivalent to roughly 1trillion euros that is short of .5 trillion euros from the day the international trade broke down in the EEC current account..
    Outstanding amounts at the end of the period (stocks), Monetary and Financial Institutions (MFIs) reporting sector – Loans [A20] and securities (ECB statistical warehouse)
    Trying to be subtle, are the figures telling the truth ?
    On GDP, no mention is made of the GDP deflator underestimating inflation by !1/3?) even when abstracting food and energy.
    On oil, last Econbrowser posts on the subject ( Brent-WTI spread) may have provided for a hint on prices make up. It is far from being a matter of true supply and demand.
    On inflation M Chinn post (Inflation Fears and Measures of Expected Inflation)
    The ADS barometer may be more explicit later in the day.
    As usual,after reading economics and finance a good book is recommended “Les Miserables” Vol xxv

  21. Jeffrey J. Brown

    As noted in the following chart showing normalized oil consumption for the US and four developing countries (100 = 1998 consumption, EIA), the post-2005 trend for the US is that we are in the position of taking what’s left over, after the developing countries take what they want, which is a pattern that I suspect we will continue to see:
    Chindia’s combined net oil imports, as a percentage of global net oil exports, rose from 11% in 2005 to 17% in 2009. A plausible estimate is that Chindia’s combined net oil imports, as a percentage of global net oil exports, will be up to about 30% in 2015.

  22. Raskolnikov

    Not to be disrespectful, but this post is kind of a tease. The question is: Will high oil prices bring a new recession?
    And the answer is: “My judgment is that, contrary to my 2003 model, there will be some contractionary consequences of recent developments, but, consistent with that model and many others, they will not be as severe as what we experienced in 2008.”
    That’s not an answer. “Not be as severe” is not an answer.
    I have a lot of respect for your analysis and candor, so I’m hopeful you’ll be clearer for the simpletons in the crowd. (like me)

  23. Doug Gabelmann

    The good news is that, high though current prices are, they actually would not trigger a response according to that relation because we are still below the highs reached less than 3 years ago.

    Using the WTI price index to compare the current price level to that of 2008 is misleading. The WTI index reflects a unique and temporary supply glut at Cushing, Oklahoma because of an increased inflow of oil from the Bakken formation, from the Canadian tar pits (copyright held by George W. Bush) and iirc from the Rocky Mtn states, and a constrained outflow due to not yet completed pipeline capacity to salt water.
    The world price for oil, reflected in any number of indices, has been at or above the level of the previous price runup since December 2008 on a month over month basis. It remains to be seen if this year’s high price will equal or surpass that of 2008, but the average price this year may well establish a new record.
    Here is a link to the U.S. Crude Oil Composite Acquisition Cost by Refiners, which is more reflective of the cost the US is bearing than is the WTI index:

  24. Jeffrey J. Brown

    As the following article notes, the Iraqis are beginning to get more realistic about their production potential, although there is some discussion to the effect that the they are adopting the Saudi position, to-wit, they are capable of eventually producing 12 mbpd, but they are choosing not to.
    In a similar fashion, if I called Julia Roberts and asked her out on a date, I am certain that she would accept, but I am choosing not to call her at the present time.
    Iraq halves oil output (target) as reality replaces ambition:
    The Times has learnt that the country’s Oil Ministry, with backing from the Prime Minister Nouri al-Maliki, will set a new target to produce between 6.5 million and seven million barrels per day by 2017, down from original plans to pump 12m barrels, according to industry insiders .
    Iraq, which is a member of the Opec cartel that pumps 40 per cent of the world’s oil, produces about 2.68m barrels per day, barely higher than under Saddam Hussein.
    It had been hoped that with a huge injection of foreign investment, it would be able to challenge Saudi Arabia as the world’s biggest oil exporter this decade.
    Confirmation that it has scrapped the old target will add to fears that global supply will be unable to keep pace with demand in coming years.

  25. Jeffrey J. Brown

    Here is a chart of annual US spot crude oil prices:
    And here are the annual spot crude oil prices and year over year exponential rates of change:
    1998: $14 (-41%/year)
    1999: $19 (+31%/year)
    2000: $30 (+46%/year)
    2001: $26 (-14%/year)
    2002: $26 (0)
    2003: $31 (+18%/year)
    2004: $42 (+30%/year)
    2005: $57 (+31%/year)
    2006: $66 (+15%/year)
    2007: $72 (+9%/year)
    2008: $100 (+33%/year)
    2009: $62 (-49%/year)
    2010: $79 (+24%/year)
    We have nine years showing positive year over year rates of change, and the median is +24%/year, within a range from +9%/year to +46%/year. Assuming that 2011 does show a year over year increase over 2010, based on these numbers, we would expect to see an average annual price for 2011 between $86 and $125, with a median expectation of about $100, which is the approximate average to date for 2011.
    The three declines are shown in bold. As I have previously noted, each successive year over year decline fell to a price level which was about twice the level reached during the previous year over year decline. If this pattern holds, the next year over year decline would bring us down to the $120 range (average annual).

  26. Darryl

    Every time there is a “analysis” who tries to explain the connection between the recession and oil prices misses one other “so-called” point. The oil companies make record profits, explain that.Please explain why they make bloated profits and we the “consumer” have to take it in the pumps!

  27. Ricardo

    Today the price of oil fell 9.4%, that’s in one day.
    For almost the entire month of April the oil:gold ratio was below 14:1 and has been below the normal 15:1 for months, ever since the unrest began in North Africa. Gold seemed to confirm the price of oil and that was troubling but today gold fell 2.8%. It appears that much of the fear has been rung out of the oil price because the ratio closed at 14.9:1.
    I would expect oil to begin to firm up unless gold continues its fall. A continued decline in the price of gold could be ominous news. Recall what happened to the economy as gold and oil declined in 2008. It signaled that the entire economy was headed into the trash bin. Let’s hope that the FED and congress do not let us slide into another deflationary contraction.
    BTW, my shorts and puts did pretty good.

  28. Steve

    Us simpletons, out here in the real world, would appreciate some WAGE inflation and some PRICE deflation. I would think with corporate and banking profits at an all time low and taxes on the wealth at an exremely low rate, that perhaps a little more in the pocket of the WORKING CLASS would be a good thing! Question?

  29. JDH

    Raskolnikov: My answer is “no”.

    Doug Gabelmann: Actually, the model I referred to is based on the U.S. producer price index for crude petroleum, which is a weighted average of prices paid by U.S. refiners.

  30. John

    In my opinion, oil prices will continue to go higher because the value of our dollar keeps going down. Same oil production but dollar is not worth much now.

  31. 2slugbaits

    JDH Do you know if anyone has ever tried to separate the effects of higher energy price volatility from the effects of higher prices. Okay, that’s not real clear, so let me try again. Intuitively we would expect that a steady and predictable increase in prices would have less of an effect on the economy than would a volatile and choppy ride up the price escalator. Presumably people are more interested in conditional variability than unconditional variability. My sense is that the current run-up in oil prices has been relatively steady, at least compared to some of the more recent experiences. Well, I guess today’s sudden drop is an exception, but for the most part it seems that oil prices have had a rather steady march upward, whereas in the past we’ve seen sudden price spikes followed by sudden price collapses and then periods of price stability. People still complain about higher gas & diesel prices, but people also seem to have accepted those higher prices in a way that suggests higher prices were anticipated. So couldn’t this be evidence that perhaps the price spike won’t have the same kind of shock effect on the economy that other oil price spikes have had?

  32. JDH

    2slugbaits: Yes, this is precisely the kind of thing I am talking about when I refer to nonlinearities which I survey in this paper. Among the studies looking at precisely your question include Lee, Ni and Ratti (1995), Hamilton (2003), and Elder and Serletis (2010).

  33. GK

    Us simpletons, out here in the real world, would appreciate some WAGE inflation and some PRICE deflation.
    a) Healthcare is eating up your wage raises. What your employer pays for your health insurance each year rises by 10%, and thus eats up what might have otherwise been your raise.
    b) Prices : Well, at least more and more technology products exist that drop at Moore’s Law rates. Look around your house, and count the number of devices that are much better than what the same price could have purchased in 2005. That goes for cars too. If you had to go back to 2005-level gadgets today, you would find them unbearably limiting.
    Points a) and b) are really the crux of the whole thing, not oil or food.

  34. Steve

    I meant bank and corps profits are at an all time high. Sorry for the miss. Very familiar with Moores Law, we had a good discussion of it yesterday, in my office, intel has kept the pace, with the 3d chip design. The problem is 80% of the working and currently non working people are not able to grasp how they fit in to the current economy. How do you stay viable when technology is doubled every 18 months and obsolete as early as 24 months. They still need to eat and get to work, when they find it. The commodities are cranking along, especially food and fuel. Most could careless about gold or silver. Now if the weather does not break within a week, the bread basket of America will start to lose yield on this years crop. Adjustments are being made by the consumer, they are buying less and paying down debt. Healthcare is not the cost driver at the working class and poor level, that is pablum. The insurance racket is as strong as ever, but people are just opting out of the system, which is their right. They are doing it, not because of the cost of healthcare, but because of the cost of food and fuel.

  35. aaron

    Unnecessarily complicated software has made Moore’s law irrelevant. I recently stopped visiting the economist website because of long page load times and it would often crash my browser.

  36. GK

    Unnecessarily complicated software has made Moore’s law irrelevant
    An ignorant statement. So you have not upgraded your phone, PC, etc. in 6 years? You have not bought any new product like an iPad, thin LED TV, etc. in 6 years?
    In fact, Moore’s Law is more relevant than most economists realize, as it has created a second type of deflation in the economy. Unlike the first sort, the second is good.

  37. Rob Ramos

    Here is a question that has been bothering me as gas prices have risen. I am sure this has a simple answer…
    Please take the second chart above and overlay the price of crude.
    Why is the spread so narrow today?
    Back in summer of 2008, oil peaked near $150 per barrel and gas prices were just over $4 a gallon.
    Today, oil (WTI) peaked around $112-113…yet gas prices are just over $4 per gallon.
    Even using Brent prices gas seems much higher today relative to the price of oil back in 2008.

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