James Hamilton, author of possibly the most comprehensive study into the macro-economic effects of the 2007-08 oil price run-up, has given his answer to the question of whether oil prices are already high enough to stifle economic recovery, and it is this:
$87 oil is certainly not helping the recovery. But I would be very surprised if it proves to be the kiss of death.
Hamilton’s own modelling suggests that oil prices have proven a somewhat reliable predictor of economic growth, suggesting that:
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.
However, he adds that the same modelling also suggests that the recovery wasn’t helped by lower oil prices, but was simply normal cyclical recovery.
While the forecast from the same model, Hamilton writes, “we wouldn’t have to worry about another oil shock until the oil price series in the top figure gets back above the values of 2008:M6 or until the 2008 highs recede farther into memory”, he is not so sure.
In effect, he points out that while $3 gasoline isn’t great during a vulnerable time, it is still a lot lower than the $4 seen not so long ago. On light vehicle sales, he says: they have already been impacted so much that it’s hard to see them going down much further. That memory is still strong, in other words – dulling the effect of rising prices now.
Finally, Hamilton notes that expenditure on energy, as a proportion of total consumption, is below the 6 per cent level that tends to herald “dramatic adjustments” in behaviour, which he charts as follows:
A few issues are worth considering, however:
1. That line is rather close to the magic 6 per cent. Hamilton’s analysis – dividing the BEA‘s ‘energy goods and services’ figure by the total ‘personal compsumption expenditure’ figure, gets us to 5.69 per cent in January 2010. Hamilton (in the comments) estimates a $1 rise in WTI equates to a 2.5c rise in gasoline per gallon; the EIA, we note, has a similar figure of 2.4c. [Unfortunately we don't know of a straightforward way of extrapolating that into the percentage of consumption.]
2. While the memory and lingering effect of $4/gallon might dampen reactions to today’s rising prices, several of Hamilton’s readers raise the very good question of what today’s constrained credit environment might mean.
3. Oil market analyst Stephen Schork has talked about a similar problem several times in recent months, although his figures come out differently to Hamilton’s, namely because he uses a different category of BEA data – the ‘gasoline and other energy goods’ column, while Hamilton takes his figure from the ‘energy goods and services’ column, which is presumably broader. The categories are difficult to find on the BEA’s own rather convoluted website, so we’ve used the Econstats.com website which Hamilton uses.
The magic number…
By Schork’s method, the percentage that signals tipping over is somewhere around 4.2 – 4.6 per cent — the range seen in November 2007 to June/July 2008.
On Schork’s category the latest data (January 2010) is at 3.58 per cent – quite a jump over the previous month’s 3.36 per cent.
Unfortunately Econstats.com does not yet have the February data converted from the BEA’s indexed measures into absolute amounts, but the release suggests that February spending on energy was down. One of Hamilton’s readers however says he calculated the February figure at 5.9 per cent, using the same category as Hamilton.
More news as it comes to hand…
Will a product squeeze see oil prices keep rising? – FT Energy Source
US driving season could show demand destruction – FT Energy Source
Gasoline vs bimbos with big hair - FT Alphaville
US consumers spending their savings on energy - FT Energy Source