Econbrowser
If you are not reading Econobrowser, you should be; consistent extraordinarily high-quality thoughts from James Hamilton and Menzie Chinn. Most recently, from Jim Hamilton:
Econbrowser: Well then, would $100 a barrel worry you? A week ago I reviewed the reasons why $90-a-barrel oil by itself would not be enough to cause an economic recession. As oil prices charged up to $96 on Friday, a reporter asked me at what price I'd change my mind.
Last week I described recent research by Olivier Blanchard and Jordi Gali and Munechika Katayama, among others, that concludes that the U.S. economy today may be substantially less vulnerable to oil price increases than it appeared to be in the 1970s. I noted that one common basis for all such claims is the observation that the fraction of our income that is spent on energy purchases is significantly lower today than it was in the 1970s. But I also noted that this is due in large part to the decline in the relative price of energy between 1981 and 1997, and that recent price increases have been reversing that trend....
The U.S. consumed 20.7 million barrels of oil per day for the first six months of 2007, which would be 7.5 billion barrels over a year. If prices today were still at the 2004 average oil price of $40 a barrel but the quantity of oil used and nominal GDP were at their values so far in 2007, $40 oil would imply an annual expenditure of about $300 billion, which would be just a little over 2% of our current $14 trillion GDP. But so far in 2007, we've seen an average oil price of $68 a barrel, which means an expenditure of $500 billion, over 3.5% of GDP. The above graph extends these calculations into some hypotheticals-- What if the oil consumption and GDP stayed where they have been so far this year, but oil prices averaged $100 or $150 over the year? It turns out that a price of $150 a barrel would put us back up to an expenditure share as high as it's ever been historically. Consumers cannot continue to ignore oil price increases for much longer.
But even if we return to those historical expenditure shares, an oil price increase need not have the same potential to produce a recession as it may have had in the 1970s. I believe that a key reason that we saw economic recessions following the oil supply disruptions of 1956, 1973, 1978, 1980, and 1990 was that these events were associated with sudden changes in consumer spending on items such as domestically manufactured automobiles, and that these demand shifts were a key cause of the subsequent economic downturns. Even if we return to a point where we are spending as much on energy as we were in 1981, the domestic auto companies are not as important to the U.S. economy as they were then....
[T]he key question as to whether an oil price increase would push the economy into a recession remains the context of the price change. The oil price increases over the last few months were not associated with any actual disruption in petroleum supplies, and do not have the same potential to change consumer sentiment and spending patterns as dramatically as occurred in many of the earlier historical oil shocks. For this reason, even if oil does go above $100, my biggest concern remains the housing sector and financial problems.
But if the tanks start rolling or missiles start flying in the Middle East, my worry factor is going to soar along with the price of oil.
