The US economic downturn of 2008 was caused almost entirely by the surge in the price of oil up to $147 per barrel last summer. That is the fascinating conclusion of economic modelling by professor James Hamilton of the University of California, San Diego.
Prof Hamilton says it is “a conclusion that I don’t fully believe myself.” But his work raises the important question of whether the role of oil in the US and global downturn has been under-estimated.
It also deals a blow to the comforting idea, promulgated by the International Monetary Fund among others, that the demand-led oil price rise of the 2000s would be more economically benign than the supply-led shocks of 1973 and 1979.
Of course, there were many other problems in the US economy last year; not least the housing crash. But house prices started to fall in 2006, and the economy continued to grow. In Prof Hamilton’s model, if the oil price was taken out of the equation, the economy would have grown throughout last year.
His paper argues:
The evidence to me is persuasive that, had there been no oil shock, we would have described the U.S. economy in 2007 Q4 to 2008 Q3 as growing slowly, but not in a recession.
Other economic models do not come up with such a powerful role for oil. But given the central importance of events such as the steep fall in vehicle sales, the general slowdown in consumer spending, and the plunge in consumer sentiment in the first half of 2008, all of which are strongly influenced by petrol prices, it does not seem implausible to think that the cost of oil was a critical factor in the downturn.
It is also possible that the green shoots that are now starting to appear are the result of oil’s fall back down to $50.
However, in case anyone was tempted to think of the oil price as yesterday’s problem, Prof Hamilton has a warning for the future.
Some degree of significant oil price appreciation during 2007-08 was an inevitable consequence of booming demand and stagnant production. It is worth emphasizing that this is fundamentally a long-run problem, which has been resolved rather spectacularly for the time being by a collapse in the world economy… If growth in the newly industrialized countries resumes at its former pace, it would not be too many more years before we find ourselves back in the kind of calculus that was the driving factor behind the problem in the first place. Policy-makers would be wise to focus on real options for addressing those long-run challenges, rather than blame what happened last year entirely on a market aberration.