NCPA - National Center for Policy Analysis

Impact Of Oil Price Rises

April 23, 2002

Oil industry observers have recently speculated how an economic recovery might be affected by a rise in oil prices. The present price is still slightly below its average of $28 a barrel in 2000-01 -- less than half the peak of 1990 in real terms. But what would a serious increase in prices do?

  • The Organization for Economic Cooperation and Development (OECD) estimated $10-a-barrel jump would increase inflation in rich countries by half a percentage point in the first year and reduce growth by a quarter of a point.
  • The impact would be greater in Europe, because while America uses more oil, it's also a producer, so net imports are smaller.
  • The economics team at Morgan Stanley calculated that if prices stayed at $40 a barrel until the end of the year -- the worst-case assumption -- world growth would be cut from 2.6 percent to 1.8 percent, the same as 2001.
  • That would make 2001 and 2002 the slowest two consecutive years ever of recorded growth.

However, as some observers point out, these figures fail to consider the impact of higher prices on consumer and business sentiment.

  • The U.S. stock market remains overvalued, say some observers, and an oil price hike might drop share prices, with more severe consequences for growth.
  • U.S. business investment is still weak, and a robust recovery relies on debt-laden consumers to continue to spend.
  • If higher oil prices and a slump in share prices were to squeeze spending by households and firms, the U.S. could tip back into recession -- and with interests rates already at 1.75 percent, the Fed has little room to cut further.

Source: "Flaring Up?" Economist, April 13, 2002.


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