Did oil cause the latest recession? IEA weighs into the debate

Though it’s universally viewed as a crisis of the financial sector’s making, several voices (notably James Hamilton) have argued the recession that began last year had a lot to do with the sharp rise in oil prices over the preceding months and years.

As long-dated oil futures contracts near $100, the oil shock question is becoming more pressing. At least Opec, which is increasing its production rapidly, seems to think so.

A feature in the draft executive summary of the IEA’s World Energy Outlook, which will be published tomorrow, revisits this argument and comes to a rather worrying conclusion.

It starts out keeping in line with the prevailing view: the run-up in oil prices from 2003 to mid-2008 played “an important, albeit secondary” role in the global economic downturn that took hold last year. Higher oil prices made oil-importing countries more vulnerable to the financial crisis, it says.

The feature concludes, however, on a somewhat stronger note.

The IEA points out that it had warned in 2006 that the effect of high oil prices from the preceding four years had not yet worked their way through the world economy, and that further increases in prices would “pose a significant threat to the world economy, by causing a worsening of current account imbalances and by triggering abrupt exchange rate realignments, a rise in interest rates and a slump in house and other asset prices”.

Remember, the IEA was essentially founded in response to the Opec oil embargoes of the early 1970s. Its original mandate was to help members – mostly the wealthy, oil importing countries – to avoid the kind of recessions seen in 1973 and 1979, which were fairly widely accepted as having oil prices as a major cause. Although its role has changed somewhat (it is also concerned with climate change and energy security), that is its key purpose.

So a strengthening belief from the IEA in the contribution of oil prices to the latest recession is especially noteworthy. We will find out on Tuesday if the final draft provides more clarity on the agency’s view.

Related links:

Comment: Searching in vain for oil shock effect (FT Energy Source, 01/09/09)
Hamilton on speculation, inflation and oil (FT Energy Source, 03/06/09)
Are oil prices threatening the world economy already? (FT Energy Source, 01/06/09)
Was the US recession caused by the oil shock of 2007-08? (FT Energy Source, 03/04/09)

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