Oil Shocks

From Econobrowser:

Dollar price per barrel of West Texas Intermediate divided by the CPI.

Econbrowser: $90 a barrel: Is it time to start worrying about the oil price shock of 2007?: Oil shocks in 1973, 1979, and 1990 were each followed by a recession. But we saw the price of oil climb from $20 a barrel in 2002 to $75 a year ago, and so far it has not resulted in a significant economic downturn. What's different now, and can we count on it to continue? The question of why the economy may be less vulnerable to oil price shocks today has been examined by a number of recent academic studies. A new paper by Olivier Blanchard and Jordi Gali identified four factors as all making a contribution: (a) good luck (i.e. lack of concurrent adverse shocks), (b) smaller share of oil in production, (c) more flexible labor markets, and (d) improvements in monetary policy.

A study last year from the Congressional Budget Office emphasized a similar list of favorable developments. Jerry Taylor and Peter VanDoren review some of the other evidence, and conclude:

All the new analyses agree that the more flexible economy that we have now, allows us to cope more easily with oil price shocks.... It is time for America to get over its inordinate fear of oil shocks. Soaring prices aren't pretty, but they are scarcely the existential threat to our economy posited by many.

Munechika Katayama, a Ph.D. candidate here at the University of California, San Diego, also has an interesting new study on this question. Katayama notes that regulation of the transportation sector during the 1970s resulted in excessive monopoly power and inefficiencies in the trucking industry, and suggests that deregulation may have been another factor that has helped the economy to respond more flexibly to oil price changes.

Comments

[bakho]

During the late 1970s, a lot of investment was made in the ability to switch energy sources and to conservation. Changes in mfg have made energy use less per unit output. Many industries installed equipment that allowed them to switch among, oil, natural gas and coal (electric). High oil prices mean that businesses switch to cheaper energy. Since that infrastructure is already in place, investments in energy conservation and efficiency are not drawing capital away from other investments.

Second, monetary policy was super-contractionary (whacko) in the late 1970s. Is it surprising that double digit interest rates were associated with economic downturn? How much of the downturn of the late 1970s was due to oil shock and how much to monetary policy? Was the 1970s monetary policy of double digit interest rates necessary? or an over-reaction?

[maynardGkeynes]

Two reasons why it's different. Maybe one: there were gas lines then, and not today (1) Gas lines killed sales of American automobiles. I remember, because I bought a Rabbit diesel at full sticker (stupidly) (2) since you had to wait on line yo buy gas, people didn't go out ands drive as much to shop and entertain themselves. The reason the economy tanked was not the price of oil, it was that you couldn't get gas at any price.

[trotsky]

Globally, oil is priced in dollars -- but in any particular country the consumer ultimately pays in local currency.

The current spike is happening even as the dollar hits a historic low -- so things aren't quite so bad in Canada, Europe, Japan, etc.

How does this compare with the situation during the last oil shock?

[bigTom]

Given all the predictions about peak oil (did world production peak in 2005, or do we still have a decade or too before the party is over?) I would not be so sanguine about the medium term (5year) prospects. If the world really has passed a supply/demand point whereby oil will be scarcity priced things may not be so easy. We may only use half the oil input per unit if GDP, but if price doubles again it is going to take a significant bite. It looks like soon only demand suppression via high price will bring the market back into balance. There is a good chance this adjustment will take a significant bite out of world GDP growth. With our weak currency the effect on the US may well be larger than for the world as a whole.

Since we have been dragging our heels on improving our oil efficiency this transition into the era of declining oil will be more painful than was necessary.

[christofay]

I think the most interesting price prediction so far regarding our Middle East allies repricing of their currency -oil- has been Gen. Petraeus call for $9 / gallon gas in the U. S. No matter what context and under what circumstances and how far from the responsibilities of his job, he made the prediction; the thing to watch for is the price target, $9 gas, how soon are we getting there?

[christofay]

Volcker fixed growth in money supply and let interest rates go where they're going, let the market decide. That's my present reading of the Volcker years. It also helped cause a grueling recession, that's the price that we are no longer willing to pay which means we accept stealth inflation and stealth unemployment (our economic state isn't as rosy as our govt figures would have us believe) and a central bank in cahoots with the Republicans. I call it Greenspanism but it is commonly part of being a banana republic.

I read this post as another rosy colored glasses report, tenured and/or inside the beltway.

(a) good luck:
yeah, we gonna need it

if I go to church on Sundays do I get extra ration coupons of it?

(b) smaller share of oil in production
Walmart sales growth has barely been matching the pace of reported inflation. The majority of Americans who live on a budget have to make choices where to spend. A tenured prof or an inside the beltwayer hasn't been pinched yet.

Anyways we're post industrial. china does that now. The price of commuting is going up. Rosy the Riveter no longer rivets, she's got a govt job producing statistics.

(c) more flexible labor markets
Again tenure and/or beltway. Was it BoA that last week declared they're firing a few thousand bankers?

(d) improvements in monetary policy
Ha

and

Greenspanism including the funny govt statistics in this case hides the backward direction of the banana republican economy.

Now if you would just go out and get a zero interest car loan to buy the SUV of your dreams you'd have the perfect ride to the unemployment office.

[christofay]

Here's the present state of our monetary policy, Kudlow playing a you don't know me crazy Mel Gibson of Lethal Weapon character went head to head with Bernanke. Bernanke blinked.

While the official stats say not bad, there are already calls for more central bank rate cuts.

[prostratedragon]

"Gen. Petraeus call for $9 / gallon gas in the U. S. "

This, I had not heard. I fear the General might know a way to get us there ...

[James Wimberley]

Is there any West Texas Intermediate left to price?

[RKimble]

There is also the question of causation. The earlier oil price rises were caused by oil supply shocks, related to cartel behavior (twice in 70s) or conflict (1990). The current price rise is caused, to some extent, by unconventional economic growth (China and India), i.e. demand shocks. The four explanations (luck, efficiency, flexible labor markets, better monetary policy) may all be valid but secondary to a situation in which trend world growth is above that during the earlier supply shocks.

[RKimble]

There is also the question of causation. The earlier oil price rises were caused by oil supply shocks, related to cartel behavior (twice in 70s) or conflict (1990). The current price rise is caused, to some extent, by unconventional economic growth (China and India), i.e. demand shocks. The four explanations (luck, efficiency, flexible labor markets, better monetary policy) may all be valid but secondary to a situation in which trend world growth is above that during the earlier supply shocks.

[RKimble]

There is also the question of causation. The earlier oil price rises were caused by oil supply shocks, related to cartel behavior (twice in 70s) or conflict (1990). The current price rise is caused, to some extent, by unconventional economic growth (China and India), i.e. demand shocks. The four explanations (luck, efficiency, flexible labor markets, better monetary policy) may all be valid but secondary to a situation in which trend world growth is above that during the earlier supply shocks.

[RKimble]

There is also the question of causation. The earlier oil price rises were caused by oil supply shocks, related to cartel behavior (twice in 70s) or conflict (1990). The current price rise is caused, to some extent, by unconventional economic growth (China and India), i.e. demand shocks. The four explanations (luck, efficiency, flexible labor markets, better monetary policy) may all be valid but secondary to a situation in which trend world growth is above that during the earlier supply shocks.

[Gray]

"There is also the question of causation."

Exactly. The difference is, during the oil shock of the 70s, the cartel only had to raise production again to get the oil flow back. The small bumps in supply caused by wars were overcome when the transport became safe again. But today we're in the era of post peak oil:
http://edition.cnn.com/2007/BUSINESS/10/24/oil.decline/

Production already is below it's high point of 2006. At the same time, economies in Asia flourish (India, China) and want more of the global share. So, demand is already above supplies, and consequently the price can only go up. It's about time the governments of industrialized nations all around the world cope with this reality and put all their efforts behind the move towards alternate, preferably renewable, energies.

[Barry]

On one of the previous threads about oil price shocks and the economy, it seemed to me like one obvious explanation was also that the labor market had permanently softened (e.g., media wages pretty flat for 30 years). The solution for the oil-shock recession was for most of the american public to take it in the wallet, to preserve the elites.

[baileyman]

"All the new analyses agree that the more flexible economy that we have now, allows us to cope more easily with oil price shocks...."

i.e., "Now we can pass price increases on to the consumers without having to boost their compensation. Big improvement."

[Fafnir]

The whole premise of the discussion is wrong, and in an obvious way. The global demand curve for oil is shifting out. That oil prices are high is the RESULT of strong global growth. The same oil price would have very different implications were it from the supply curve shifting in.

[D-Slam]

fafnir: "The same oil price would have very different implications were it from the supply curve shifting in."

So... where is the increase in production that should result from $90 oil? Bueller? Bueller?

We're DOWN from 2006. My little Econ 101 supply/demand graph does not allow for this possibility... unless the supply curve is shifting in.

Econobrowser has another earlier article about decline in the Ghawhar field that should give us all the willies.

[Mandos]

That can't be *the* Fafnir, can it? Doesn't sound like him.