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Tuesday, April 13, 2010

373 Crisis in Europe, Oil Prices and the hard slog

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Today we are going to dip our toe in the current crisis in Europe with some audio from James K. Galbraith and Joseph Stiglitz,  take just a minute on oil prices, and finish with another vignette from the Sarkozy Report.

Caught by Bloomberg in Cambridge, England, at the inaugural conference for INET -- the Institute for New Economic Thinking -- James K. Galbraith continued his annoying practice of applying perspective to the current Greek crisis.


James K. Galbraith

Also caught for a few words was Joseph Stiglitz


Joseph Stiglitz

Quickly on to oil prices.

A year ago, oil was in the $45 per barrel range.  Now it is around $85.  True, most of that rise occurred in the first two months, but the trend has been up.
Demand Side makes a special point of oil prices.  In particular, oil prices and interest rates have been shown by Andrew Oswald and others to predict recessions.  The demand side effect is not difficult to describe.  Oil prices subtract from both consumers and producers bottom lines.  Oil prices generally lead other energy prices higher.  This is a demand side shock.
Over the weekend, James Hamilton of Econobrowser took up the question, beginning

Do rising oil prices threaten the economic recovery?

Ten of the 11 recessions in the United States since World War II have been preceded by a sharp increase in the price of crude petroleum. Oil had been holding around $80/barrel over the last month, but traded as high as $87 last week, leading the Financial Times to ask whether oil could give the "kiss of death to recovery."
and he produces some interesting charts before answering his question:
Americans buy a little less than 12 billion gallons of gasoline in a typical month. With gas prices now about a dollar per gallon higher than they were a year ago, that leaves consumers with $12 billion less to spend each month on other things than they had in January of 2009. On the other hand, the U.S. average gas price is still more than a dollar below its peak in July of 2008. Changes of this size can certainly provide a measurable drag or boost to consumer spending, but are not enough by themselves to cause a recession.

Average U.S. retail price of gasoline (dollars per gallon). Source: NewJerseyGasPrices.com.

My view is that it is not just the level of consumer spending but also a sudden change in its composition that sometimes contributes to an economic recession. When oil price increases are sufficiently sudden and dramatic, we see abrupt drops in consumer sentiment, postponement of purchases of consumer durables, and important changes in the kinds of vehicles consumers buy. Because labor and capital can not costlessly shift out of the affected industries, the result is unemployment in those sectors which is an important additional factor bringing the economy down.

Demand Side breaks in here to note that indeed the volatility of oil prices is a major problem.  It prevents alternative technologies from knowing whether they will pencil out financially.  Businesses that would be viable competing with $100 per barrel oil may have no customers at $90.  Since the investment in these projects is necessarily long-term, the volatility and uncertainty of prices is often a deal breaker.
The downturn was more severe than could be attributed solely to the oil shock of 2007-2008, but that shock appears to have been an important contributing factor, and the overall path followed by GDP up to this point is very similar to the 2-year-ahead prediction.

Energy expenditures as a fraction of consumer spending. Calculated as 100 times nominal monthly consumption expenditures on energy goods and services divided by total personal consumption expenditures. Data source: BEA Table 2.3.5U, "Personal Consumption Expenditures by Major Type of Product and Expenditure," obtained from Econstats. Dashed line is drawn at 6.0%.

So to return to the question posed at the beginning: $87 oil is certainly not helping the recovery. But I would be very surprised if it proves to be the kiss of death.
This is good evidence of economists tendency to view things as if in petri dish, when they occur in real life.  Of course, the levels of oil prices we have seen are not helping.  A rise in prices will not help.  And this is particularly true in the context of financial weakness.  A price rise today will have a serious effect on demand.  It is our view, contrary to Professor Hamilton, that the drop in gasoline prices after July 2008 did have its follow-on effect, typically lagged by several quarters.  But it was modest, because the drop in prices was modest and short-term.
The recovery

Before we get into the next section of the Sarkozy Report, let's reflect on our recent history.  One thing you notice when you compare the GDP numbers for the postwar recessions is that they have become less defined, particularly in their recovery.  As we've talked recently, GDP measures activity, not well-being or economic health.  Not prosperity.  But the charts are for GDP are instructive, in that they illustrate what Hyman Minsky observed thirty years ago, that the process of bailing out the financial innovation loaded the economy with debt that subsequently slowed recoveries.
The observation is more striking with employment.  The bowl of employment loss was deeper and narrower in the early recessions.  Until the most recent one, the bowl had grown wide, but more shallow.  Some of this has to do with the recalibrating of what is unemployed.  Some has to do with the increased emphasis on GDP and lesser emphasis on jobs.  But some also has to do with the quality of the economy.  A jobless recovery is an oxymoron.  Now we have deep and wide.

The famous statistic is that we did not add one job in the aughts, but we added 30 million people.

We were instructed by the Sarkozy Commission that median income is the measure of well-being that best filters out the noise of GDP and elminates the error of averaging.  I would love to be able to put my finger on that number, but the best I could do for anything current was total personal income.  Flat in February.  I will bet that median income is still falling, because I will bet that incomes in the lower half are falling and those at the top are rising.

This is not a hard slog out.  This is a hard slog going nowhere.

1 comment:

  1. Oil price can be a drag on the economy. Though it depends where the funds are going. In Europe we have had to face the same problem of high oil prices at the same time as the US. Though the European and Japanese solution is to choke off demand through high oil taxes. This transferred some of the retail price of oil back to the national treasury rather than to OPEC. This revenue could be used for other investment in efficient production etc.

    This means that during the last oil price shock both Europe and Japan suffered far less than the US. Europe and Japan had a higher GDP output per barrel of oil than the US. The additional benefit is that both areas are far better prepared to cope with future oils shocks as a result of peak oil than the US. It gives governments scope to freeze petroleum taxes when prices are high, so balancing out the price movements.

    Cheap oil has been a huge burden for the US, in that it masks inefficiencies in the economy. It enabled the big three US auto makers to avoid the investment in efficient models for the US, and so allowed Toyota to do so well in the US. It hammered them when the oil price rose to $140+ a barrel. The US consumer with years of stagnant wages simply could not cope with high oil prices.

    The oil price may have had some impact on this recession but the real cause has been the implosion of the credit bubble. With no credit all the other house of cards will simply fall.