Consumer Energy Report is now Energy Trends Insider -- Read More »

By James Hamilton on Mar 9, 2012 with 5 responses

Why Current High Oil Prices Won’t Derail the U.S. Economy

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.

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 2.4.5U. 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.

This article originally appeared on Econbrowser.

  1. By Risk_Transfer on March 9, 2012 at 3:01 pm

    I agree that if gas prices in the US were to remain flat for the rest of 2012 they are not high enough to derail the economy a second time.  IMO this is due to people’s increased resiliency as a result of the high prices seen in 2007/08 and the recessionary-level spending that people have grown accustomed to.  I like the information regarding big expenditures-such as vehicles-that are influenced by gas prices, but I am curious about the change in trends of vehicle-miles driven or air-miles flown.

    Given that it is only March and prices are due to increase at the very least with the onset of summer fuel blends, prices may still see an all-time high this year.  There is a very real possibility of imminent regional spikes due to hurricanes (a la Katrina) in the southeast and/or refinery closures in the northeast.  It will be interesting to see if at that point the US will more slowly enter a double-dip recession rather than crash into one.  As long as the economy slowly shrinks instead of crashes, will that be enough to minimize alarm?

    [link]      
  2. By ed on March 10, 2012 at 10:45 am

    You did not comment on the effect on prices of consumer good and especially food that requires vehicle transportation to the end customer. I have already seen increased delivery costs  in my small, home based business and this has cut into my profit. I will have to raise my prices soon as possible.  It may take a while before all the competition sees the need but based on previous experiences, it will happen in the next  2 to 3 months.

    [link]      
  3. By Muchos Huevos on March 10, 2012 at 11:21 am

    Then how come countless families are starting to loose their homes? other parents getting desperate to the point of killing their families and themselves like it happened back in 2008?? problem is most speculators can afford it and never seem to notice a lot of things, in fact, most of EUROPE economic problems steemed from that, and again, nobody seems to be able to connect the dots.

    I know the world is upset and looking for alternatives to oil for transportation, and I do not mean using food products to make ethanol, Tesla’a electric car concept is being finally developed as of this very minute, plus other projects being worked out the world over, I know soon will come up to see the light.

    [link]      
  4. By Optimist on March 16, 2012 at 9:29 pm

    The last graphic sums it up nicely: we’re spending less than 10% on energy. Even if energy were to get a lot more expensive, most people would be able to cope, by cutting in other areas. Of course, that cutting would have some effect on the overall economy.

    Not sure the first chart supports the thesis: we’re within striking range of all time high. As Risky points out, a typical summer increase could easily take us to a new all time high. Would that mean double dip?

    [link]      
  5. By Optimist on March 16, 2012 at 9:39 pm

    Then how come countless families are starting to loose their homes?

    Did you miss the whole financial industry meltdown?

    other parents getting desperate to the point of killing their families and themselves like it happened back in 2008??

    And this is happening where?

    problem is most speculators can afford it and never seem to notice a lot of things…

    The Blame-the-speculators game is getting old, Mr. Obama! Speculators actually help to stabilize prices. Contrary to popular belief, they also don’t eat puppies for breakfast.

    …in fact, most of EUROPE economic problems steemed from that, and again, nobody seems to be able to connect the dots.

    How did Europe’s problems stem from expensive gas, seeing as they use so much less oil per person than Americans?

    [link]      
Register or log in now to save your comments and get priority moderation!