BanglaBhoot
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by James Surowiecki
How fast the world turns. Only a few months ago, as consumer spending evaporated and commodity prices collapsed, investors and policymakers were haunted by the spectre of deflation. Today, with the economy showing some signs of bottoming and commodity prices back on the rise, the worry du jour has suddenly become inflation. Much of this anxiety is just a matter of looking for a lead lining in every cloud; long-term interest rates, after all, remain historically low, and theres little evidence of inflationary pressures in the economy as a whole. But there is one bit of inflation that cant be written off so confidently: oil prices, after falling more than a hundred dollars a barrel last year, have roughly doubled this year, sending gasoline prices up more than sixty per cent and leaving Americans paying about a dollar more per gallon than they were in December. Many worry that higher prices at the pump could end up choking off the economys putative green shoots before theyve even had a chance to grow.
This isnt an idle concern, since recent history demonstrates how damaging skyrocketing oil prices can be. Indeed, blame for the current recession can be laid in part on the spike in the price of oil between June of 2007 and July of 2008, when it peaked at nearly a hundred and fifty dollars a barrel. A study by James Hamilton, a macroeconomist at U.C.-San Diego, reached a startling conclusion: given the already weak state of the U.S. economy in 2007, the sharp increase in oil prices might have been enough, on its own, to tip the economy into recession, even without that years blowup in the credit markets. It wasnt just that, as many people assume, higher gas prices functioned as a tax increase, taking money out of peoples pockets. More important was the fact that four-dollar-a-gallon gasoline dramatically changed the way people spent their money. In particular, it killed demand for S.U.V.s and big cars; S.U.V. sales were down more than twenty-five per cent by the middle of last year. And, since these were the vehicles that American automakers relied on for most of their business, job cuts soon followed (a hundred and twenty-five thousand auto manufacturing jobs were lost between 2007 and 2008), with ripple effects for the entire economy. The price spike had other consequences, too; some have suggested that it magnified the housing bust by making long commutes to the overpriced exurbs less attractive. And this all created a classic oil shock, like the one that hit the economy in the early nineteen-seventies.
Given that dismal experience, do todays rising oil prices mean that were doomed? Not necessarily. To begin with, not all jumps in the price of oil turn into shocks. Between 2001 and 2006, for instance, the price of oil tripled, and yet the economy seemed to suffer few ill effects: inflation was stable, unemployment low, and economic growth reasonably strong. And, even after the recent run-up, oil prices are simply back where they were for much of 2006. Whats more, higher gas prices probably cant do the same kind of damage they did last year because of the havoc they have already caused: G.M., Ford, and Chrysler have been dramatically downsized since then, and auto sales in general have fallen so far that the decline probably cant get much worse. All in all, a reprise of last years oil crisis seems unlikely.
That doesnt mean, though, that theres nothing to worry about. Expensive gas often has a psychological impact as well as a material one. Although there is no one-to-one correlation between gas prices and consumer confidence, a 2007 study by the economists Paul Edelstein and Lutz Kilian showed that, historically, sharp spikes in oil prices have sent consumer confidence plummeting, and have led to outsized cutbacks in general consumer spending. This makes sense: gasoline prices are the most publicly visible prices in the economy as a wholeno other prices are displayed on the street in bold, two-foot-tall numbersso its not surprising that they have a disproportionate impact on the way people feel. Whats tricky is that economists dont have a clear sense of what distinguishes a sharp spike from a normal rise in prices: up to a certain point, higher prices seem to make only a minor difference, but, once that point is reached, they begin to do real damage. (In other words, $2.75 a gallon may be sustainable, but $3.50 a gallon may not.) In large part, it may be a matter of expectations: if consumers see the current increase in prices as a return to normal levels, it will hurt much less than if they see it as a radical shift or a harbinger of future increases.
Even if we weather this increase, though, the problem wont go away: unlike past oil spikes, which were the result of supply disruptions, todays oil prices are driven mainly by the rise in demand from places like China and India, so, unless the economy falls back into the abyss, theyre unlikely to decrease sharply. What were hoping for is a Goldilocks solution, where the economy starts to boom again but the price of oil doesnt. Perhaps well get it. But, rather than leave so much of our fate to chance, wed be better off doing what politicians always say they want to do: lessen the U.S. economys dependence on oil. One step toward that would be to phase in a gas tax designed to smooth out oils spikes and plunges by keeping the price of gasoline fixed (the tax would rise when the price of gas fell, and vice versa). Raising gas taxes is, of course, a solution that politiciansand votershate. But perhaps another oil shock or two will change that. ♦
How fast the world turns. Only a few months ago, as consumer spending evaporated and commodity prices collapsed, investors and policymakers were haunted by the spectre of deflation. Today, with the economy showing some signs of bottoming and commodity prices back on the rise, the worry du jour has suddenly become inflation. Much of this anxiety is just a matter of looking for a lead lining in every cloud; long-term interest rates, after all, remain historically low, and theres little evidence of inflationary pressures in the economy as a whole. But there is one bit of inflation that cant be written off so confidently: oil prices, after falling more than a hundred dollars a barrel last year, have roughly doubled this year, sending gasoline prices up more than sixty per cent and leaving Americans paying about a dollar more per gallon than they were in December. Many worry that higher prices at the pump could end up choking off the economys putative green shoots before theyve even had a chance to grow.
This isnt an idle concern, since recent history demonstrates how damaging skyrocketing oil prices can be. Indeed, blame for the current recession can be laid in part on the spike in the price of oil between June of 2007 and July of 2008, when it peaked at nearly a hundred and fifty dollars a barrel. A study by James Hamilton, a macroeconomist at U.C.-San Diego, reached a startling conclusion: given the already weak state of the U.S. economy in 2007, the sharp increase in oil prices might have been enough, on its own, to tip the economy into recession, even without that years blowup in the credit markets. It wasnt just that, as many people assume, higher gas prices functioned as a tax increase, taking money out of peoples pockets. More important was the fact that four-dollar-a-gallon gasoline dramatically changed the way people spent their money. In particular, it killed demand for S.U.V.s and big cars; S.U.V. sales were down more than twenty-five per cent by the middle of last year. And, since these were the vehicles that American automakers relied on for most of their business, job cuts soon followed (a hundred and twenty-five thousand auto manufacturing jobs were lost between 2007 and 2008), with ripple effects for the entire economy. The price spike had other consequences, too; some have suggested that it magnified the housing bust by making long commutes to the overpriced exurbs less attractive. And this all created a classic oil shock, like the one that hit the economy in the early nineteen-seventies.
Given that dismal experience, do todays rising oil prices mean that were doomed? Not necessarily. To begin with, not all jumps in the price of oil turn into shocks. Between 2001 and 2006, for instance, the price of oil tripled, and yet the economy seemed to suffer few ill effects: inflation was stable, unemployment low, and economic growth reasonably strong. And, even after the recent run-up, oil prices are simply back where they were for much of 2006. Whats more, higher gas prices probably cant do the same kind of damage they did last year because of the havoc they have already caused: G.M., Ford, and Chrysler have been dramatically downsized since then, and auto sales in general have fallen so far that the decline probably cant get much worse. All in all, a reprise of last years oil crisis seems unlikely.
That doesnt mean, though, that theres nothing to worry about. Expensive gas often has a psychological impact as well as a material one. Although there is no one-to-one correlation between gas prices and consumer confidence, a 2007 study by the economists Paul Edelstein and Lutz Kilian showed that, historically, sharp spikes in oil prices have sent consumer confidence plummeting, and have led to outsized cutbacks in general consumer spending. This makes sense: gasoline prices are the most publicly visible prices in the economy as a wholeno other prices are displayed on the street in bold, two-foot-tall numbersso its not surprising that they have a disproportionate impact on the way people feel. Whats tricky is that economists dont have a clear sense of what distinguishes a sharp spike from a normal rise in prices: up to a certain point, higher prices seem to make only a minor difference, but, once that point is reached, they begin to do real damage. (In other words, $2.75 a gallon may be sustainable, but $3.50 a gallon may not.) In large part, it may be a matter of expectations: if consumers see the current increase in prices as a return to normal levels, it will hurt much less than if they see it as a radical shift or a harbinger of future increases.
Even if we weather this increase, though, the problem wont go away: unlike past oil spikes, which were the result of supply disruptions, todays oil prices are driven mainly by the rise in demand from places like China and India, so, unless the economy falls back into the abyss, theyre unlikely to decrease sharply. What were hoping for is a Goldilocks solution, where the economy starts to boom again but the price of oil doesnt. Perhaps well get it. But, rather than leave so much of our fate to chance, wed be better off doing what politicians always say they want to do: lessen the U.S. economys dependence on oil. One step toward that would be to phase in a gas tax designed to smooth out oils spikes and plunges by keeping the price of gasoline fixed (the tax would rise when the price of gas fell, and vice versa). Raising gas taxes is, of course, a solution that politiciansand votershate. But perhaps another oil shock or two will change that. ♦
