Oil Prices and the U.S. Economy

March 14th, 2012
in Op Ed

by James D. Hamilton, reproduced from EconBrowser.com

Here's why I believe that the current high price of oil is not enough to derail the U.S. economic recovery.

Although the prices of oil and gasoline have risen significantly from their values in October, they are still not back to the levels we saw last spring or in the summer of 2008. There is a good deal of statistical evidence (for example, [1], [2]) that an oil price increase that does no more than reverse an earlier decline has a much more limited effect on the economy than if the price of oil surges to a new all-time high.

Follow up:

More New Jersey Historical Gas Price Charts provided by GasBuddy.com

One reason for this is that much of the impact on the economy of an increase in oil prices comes from abrupt changes in the patterns of consumer spending. For example, one thing we often observe when oil prices spike up is that U.S. consumers suddenly stop buying the less fuel-efficient vehicles that tend to be manufactured in North America. That drop in income for the domestic auto sector is one factor aggravating the overall economic consequences. But if consumers have recently seen even higher prices than they're paying at the moment, their spending plans and firms' production plans are likely already to have incorporated that reality.

For example, take a look at February sales of domestic light trucks, which includes SUVs. These were up a bit from last year, but are still 28% below February 2007. Since the original spike in gas prices in 2007-2008, Americans have never gone back to buying the larger vehicles in the numbers we used to.

Data source: Webstract

By contrast, here's a plot of sales of domestically manufactured cars. Sales for February 2012 set an all-time high for this category. Again, historically when oil prices make an all-time high, what we often see is American consumers spending their money on more fuel-efficient imports rather than the domestic vehicles. But this time, Detroit was already in position with the kind of cars people want when the price of gasoline is higher.

Data source: Webstract

Of course, there are other channels by which higher oil prices exert a drag on the U.S. economy besides the domestic auto sector. Another series I pay close attention to is the share of total consumer spending that is eaten up by the cost of energy. But the remarkable thing here is that nominal consumer spending on energy goods and services actually declined on a seasonally adjusted basis between September and January, even as the price of gasoline was going up considerably. This represents a combination of an unusually mild winter, very low natural gas prices, and consumers finding ways to reduce their energy consumption and thereby insulate their budgets from some of the damage of higher gasoline prices.

Energy expenditures as a percentage of consumer spending, 1959:M1 to 2012:M1. Calculated as 100 times nominal monthly consumption expenditures on energy goods and services divided by total personal consumption expenditures. Data source: BEA Table 2.4.5 U. Blue line is drawn at 6.0%.

If  tensions with Iran were to escalate, then I would start to worry a good deal more. But based on what has happened to oil prices so far, I find myself in the unusual position of being less concerned about the impact of oil prices on the U.S. economy than many other analysts.


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About the Author

Professor James D. Hamilton receieved his Ph.D from the University of California Berkley. Amoung his many scholarly recognitions, achievements and awards, he has also written and published on a variety of topics ranging from econometrics to energy markets. His graduate textbook concerning time series analysis has over 10,000 scholarly citations and has been translated into multiple languages. Currently he is a professor of economics at the University of California San Diego and writes for the blog, EconBrowser.com.


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