Will the Run Up in Gas Prices Push the Economy Back Into Recession?

March 14, 2011

What would happen to the U.S. economy if petroleum prices continue their rapid rise?  University of California, San Diego, economist James Hamilton noted in a recent study that 10 out of 11 post-World War II recessions in the United States were preceded by a sharp increase in the price of crude petroleum.  The only exception was the mild recession of 1960-1961, says Ronald Bailey, Reason Magazine's science correspondent. 

So how do oil shocks cause recessions?

  • One of the key ways oil price hikes negatively affect the U.S. economy is by provoking a decline in demand for new automobiles.
  • Unemployed autoworkers and idled factories cannot be rapidly deployed to other sectors.
  • In addition, uncertainty over oil prices also leads people and firms to postpone purchases of capital and durable goods.
  • While higher oil prices contribute to recessions, lower oil prices do not appear to have much effect on economic expansions -- people may postpone buying a new car when gas prices are high, but they do not rush out to buy one just because pump prices are low.

So will the recent run up in the price of crude push the U.S. economy back into recession?  On March 1, Federal Reserve Chairman Ben Bernanke testified that "sustained rises in the prices of oil or other commodities would represent a threat both to economic growth and to overall price stability, particularly if they were to cause inflation expectations to become less well anchored."

The price of oil spiked briefly in 2003 as the result of a strike in Venezuela and the launching of the Second Persian Gulf War.  Hamilton points out that actual oil production didn't decline that much and he believes that strong economic growth rode out that short-term price increase.  More worryingly, back in 1973 commodity prices also surged dramatically, which coupled with a doubling in the price of oil, resulted in a deep recession.  So, is this 1973 or 2003?

Source: Ronald Bailey, "Oil Price Shocks and the Recession of 2011?" Reason, March 8, 2011.

For text:

http://reason.com/archives/2011/03/08/oil-price-shocks-and-the-reces

For study:

http://weber.ucsd.edu/~jhamilto/#working

 

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