Don’t Stop Worrying About Tomorrow

January 9th, 2012 at 8:16 pm

Just in case you’re being lulled into good feelings about the current economy, I wanted to share some poking around I’ve been doing re the impact of oil price spikes.  This goes back the second figure in this post, showing strains potentially building in global oil capacity.  (Read James Hamilton for authoritative analysis of the oil/macroeconomy nexus—he’s worried about this too.)

Rules of thumb here are as follows, though in a moment I’ll give you some reasons why they could be wrong.

–A $10 increase in the cost of oil leads to about 25 cents more per gallon at the pump.

–Every extra penny at the pump takes around a billion dollars from disposable income for other consumption.

–That same $10 increase, if sustained for a year, shaves about 25 basis points (one-quarter of a percentage point) off of real GDP growth.

–Adding rules of thumb, for each percentage point that real GDP grows below trend, with trend around 2.5%, the unemployment rate goes up a half a percentage point.

[Pit stop: the price of benchmark crude went up something like $20 bucks over the past year, shaving one-half of a point off of real GDP growth, which was 1.5%, 2010q3-2011q3.  So stacking rules of thumb, and remembering that the invisible hand itself can be all thumbs, that increase may have shaved half-a-point of off GDP growth, and added 25 basis points on the unemployment rate, which amount to 375,000 more unemployed people!]

Now, forecasts for real GDP growth next year have us at or a bit below trend.  Adding the fact that we’re creeping up on global capacity, well…if a whale sneezes, or worse, in the Strait of Hormoz, you get the picture.

As promised, some caveats.  First, China has been a large and growing energy demander in recent years and there’s some evidence that their economy is slowing.  That could lead to other problems, of course, but in this context, it could be an escape valve for the capacity issue.

Second, the rules of thumb above assume historical relationships.  As I’ve written elsewhere, perhaps another rule of thumb—Americans respond inelastically to gas price increases—needs a rethink.  Or at least an adjustment for real income losses.

Miles driven, as shown in this fascinating chart from the Federal Highway Administration, declined quite significantly in historical terms in the Great Recession and haven’t recovered much.  So, at least in this period of high unemployment, real wage, and real wealth losses, people appear to be adjusting to higher prices at the pump by driving less and that may insulate us somewhat from the potential problems elaborated above.

Stay tuned—movements in the price of oil and our behavioral responses to them are always important, and in an election year, they can become..um…particularly germane.

SourceL Federal Highway Administration, link above.

Update: more detail on oil rules of thumb (hat tip: JC).

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7 comments in reply to "Don’t Stop Worrying About Tomorrow"

  1. Tyler says:

    It’s kind of a bummer that an economic recovery will produce two things: a lower unemployment rate and higher oil prices. I wish it was only the former.

    Everyone seems to agree that the economy is issue number one, but sometimes I think our highest priority should be energy independence.


  2. Mavis Beacon says:

    Unemployed people drive less…


  3. fausto412 says:

    whatever good feelings I could have were killed when I learned recently that my employer would end 401k matching.


  4. cat says:

    So because the US didn’t get serious about its energy policy the increasing cost of oil is going to slow our already meager GDP growth?

    And because we allow naked future trading of oil we allow people to siphon off huge sums of money from our economy and lower our GDP growth?

    Its akin to allowing naked future trading in plasma or clean water. It seems like a terrible idea.


  5. Atypical says:

    I would like to see any serious article on oil prices always discuss the effect of speculators. Their involvement, as cat says above, is critical to a proper understanding of this issue.

    Market fundamentals are never the overwhelming reason for any price movement in this industry. The CEO of Exxon not long ago said so.

    So there!


  6. the buckaroo says:

    …I’m fond of the Fed Import Export figures on oil. Check the export of refined products. We drive less…they export more. Supply & demand is a free market issue, it seems, just not our market.


  7. Alex says:

    Jared, interesting post and chart. Maybe it doesn’t make a difference to your conclusion but….

    “So, at least in this period of high unemployment, real wage, and real wealth losses, people appear to be adjusting to higher prices at the pump by driving less and that may insulate us somewhat from the potential problems elaborated above.”

    …..couldn’t the drop off rather be because AD has dropped so there’s less requirement to travel: goods deliveries decline, as Mavis suggests: unemployed people don’t drive to work anymore etc… rather than gas prices being the overall factor?


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