May 1, 2005

NAUGHT BUT PSYCHOLOGICAL:

OIL CHANGE (James Surowiecki, 2005-05-02, The New Yorker)

It may be hard to be blasé when you’re paying $2.50 a gallon at the pump, or if you’re the chairman of a major airline, but there is surprisingly little evidence that high oil prices have anywhere close to the effect on our economy that we seem to believe they do. They matter, of course, but, of all the reasons to be concerned about America’s economic standing, oil, believe it or not, belongs pretty far down on the list.

Why such a lowly rank for the economy’s so-called lifeblood? Haven’t most postwar recessions been accompanied by rising oil prices? Indeed they have. But correlation is not causation, and all oil spikes are not created equal. The fact that the geopolitical oil crises of the seventies hurt the economy doesn’t say much about what high prices will do to us now, in the absence of a crisis.

When you look closely, it is hard to know what effect, exactly, oil prices have on the economy. For instance, higher oil prices are often assumed to be inflationary—that is, they raise prices. But Mark Hooker, a former economist at the Federal Reserve, has shown that since 1980 higher oil prices have had essentially no effect on over-all inflation. Higher oil prices are also said to create uncertainty, which causes consumers and businesses to hold off on major purchases and investments, thereby slowing down the economy. But there’s little evidence of this. Robert Barsky and Lutz Kilian, economists at the University of Michigan, have found that in the past three decades higher oil prices have had no consistent effect on whether or not consumers kept buying cars or expensive household items like washing machines. (The oil spike of 1979 led to less car buying. The oil spike of 1980 led to more. Or maybe it all had to do with Lee Iacocca.) Oil shocks have also had no predictable impact on corporations’ decisions about whether to invest in equipment or new plants.

Higher prices do function as a kind of tax increase that raises the cost of doing business (with the proceeds effectively going to foreign exporters). But the size of this tax is too small to create a meaningful slowdown on its own. And, while there’s some evidence that higher energy costs increase unemployment when oil-dependent industries lay people off, the number of jobs lost is too small to disrupt the economy as a whole.

More recently, steep rises in the price of oil have accompanied healthy economic growth—in 1999-2000 and in the past few years, for example. Declines in oil prices have not necessarily sparked economic booms, either. And recessions haven’t always been triggered by high oil prices. The downturns of 1973 and 1990 started even before the oil shocks occurred, which suggests that oil wasn’t solely to blame (though it undoubtedly made things worse). In the past thirty-five years, there has not been a single case in which high oil prices have thrown an otherwise propulsive economy into reverse.

The point is not that oil spikes are irrelevant but that they don’t have any kind of predictable or consistent impact.


They just scare the bejeebies out of people.

Posted by Orrin Judd at May 1, 2005 11:15 PM
Comments

All prices are psychologically-driven. Economics is a social science.

Posted by: ghostcat at May 2, 2005 12:08 AM

"It may be hard to be blas when youre paying $2.50 a gallon at the pump..."

Man, it is great to be an American. We have the world's most powerful military (there is no 2nd place), the strongest economy (there is no 2nd place), the best universities, the best hospitals, the best of pretty much everything. And life is so easy that we are sent into fits of rage over gas prices that are lower than what we pay for milk. How sweet it is, to be us.

Posted by: b at May 2, 2005 12:25 AM

Higher prices do function as a kind of tax increase that raises the cost of doing business (with the proceeds effectively going to foreign exporters). But the size of this tax is too small to create a meaningful slowdown on its own.

Luckily, oj has a plan to fix all that.

Posted by: joe shropshire at May 2, 2005 12:31 AM

joe:

It does prove the point.

Posted by: oj at May 2, 2005 12:41 AM

b:

The only difference being that most people don't go out and buy 10 gallons of milk at a time.

That said, you're right -- America is a great place and if I choose to exercise my natural American right to bitch about everything, high gas prices are way down on my list (besides, I'm impecunious and consequently drive a tiny '89 Toyota Corolla, so in some zen way my poverty keeps me from paying more for fuel). For example, you'll note that the Yankees are coasting along at .400 and have just dropped three straight series, all of them at home. This must somehow be OJ's fault.

Posted by: Matt Murphy at May 2, 2005 1:43 AM

What point? That foolish policy can stop an economy cold? We know that already, oj, believe me, you do not have to demonstrate that again.

Posted by: joe shropshire at May 2, 2005 1:43 AM

OJ:

Note this line:

The point is not that oil spikes are irrelevant but that they don't have any kind of predictable or consistent impact.

But they scare the bejeebies out of people! That's predictable and consistent!

Posted by: Matt Murphy at May 2, 2005 1:50 AM
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