OIL WE HAVE, IT'S PERSPECTIVE WE LACK (via John Resnick):

Taking Some of the `Shock' Out of Oil Prices (Caroline Baum, 5/12/04, Bloomberg)

Even if you ignore the timing issue, linking recessions to oil prices ignores one not-so-small piece of the puzzle: how the central bank reacts.

The Fed pushed the federal funds rate up from 6.5-6.625 percent in March 1988 to 9.75-9.875 percent in February 1989. (There were ranges in those days because the funds rate target was a closely guarded secret.) The banking system was reeling under the weight of bad real estate loans, reducing financial institutions' ability to lend.

In spite of the Fed's subsequent aggressive effort to stimulate the economy -- it lowered the funds rate from 9.875 percent in June 1989 to 3 percent in September 1992 -- the early 1990s witnessed the slowest broad money growth in history. The temporary jump in oil prices months after the recession started was the least of the economy's worries.

Oil prices hit $40 a barrel last Friday, a 52 percent increase from a year ago. However shocking the price is -- remember the Economist Magazine's ``$5 Oil'' cover on March 6, 1999? -- it's hard to make a case for a supply shock when both OPEC and non-OPEC producers have been increasing production. (In an e-mail response to questions, Roach clarified that ``$40 is high but the shock comes at $50.'')

A supply shock is a specific microeconomic phenomenon expressed by a shift inward (to the left) in the supply curve, which is upward sloping: The quantity supplied by producers is higher at higher prices.

"If there's no fall in the quantity, it's not a supply shock,'' says Bob Laurent, professor of economics and finance at the Illinois Institute of Technology's Stuart School of Business.

So long as Chairman Greenspan keeps his head about him and doesn't start cranking rates there's no problem. Unfortunately, he still thinks it's 1973.

Posted by Orrin Judd at May 12, 2004 1:48 PM