The Effects of the Recent Oil Price Shock on the US Economy

Oil & The Economy Oil prices have a stagflationary effect on the economy Oil prices have a stagflationary effect on the economy They slow the rate of growth of the economy and could actually lower the level of output (i.e. create a recession)They slow the rate of growth of the economy and could actually lower the level of output (i.e. create a recession) They lead to an increase in the price and possibly an increase in the inflation rateThey lead to an increase in the price and possibly an increase in the inflation rate Oil prices act like a tax with the revenues going to oil producers rather than the governmentOil prices act like a tax with the revenues going to oil producers rather than the government

Factors Size of the shock in both level and growth Size of the shock in both level and growth

Oil Prices The current 65% increase is comparable to the increases in 2000 (although from a very low level of $15) and 2003 The current 65% increase is comparable to the increases in 2000 (although from a very low level of $15) and 2003

Oil Prices It is dwarfed, however, by the 1973 increase (135% increase to a real price of $43) and the 1979 increase (210% increase to a real price of $82) It is dwarfed, however, by the 1973 increase (135% increase to a real price of $43) and the 1979 increase (210% increase to a real price of $82)

Factors Size of the shock in both level and growth Size of the shock in both level and growth Persistence Persistence The current price of oil primarily reflects Chinese demand and a middle east “Fear Premium”The current price of oil primarily reflects Chinese demand and a middle east “Fear Premium”

Factors Size of the shock in both level and growth Size of the shock in both level and growth Persistence Persistence The current price of oil primarily reflects Chinese demand and a middle east “Fear Premium”The current price of oil primarily reflects Chinese demand and a middle east “Fear Premium” US Dependency US Dependency US dependency has fallen (by about 50% since 1980), but our production has fallen as well (imports of oil amount to 1.2% of GDP compared to.9% in 1970)US dependency has fallen (by about 50% since 1980), but our production has fallen as well (imports of oil amount to 1.2% of GDP compared to.9% in 1970)

Estimates Private sector estimates suggest two scenarios: Private sector estimates suggest two scenarios: A persistent level of $35/Brl will cost the US approximately.3-.5% of GDP growthA persistent level of $35/Brl will cost the US approximately.3-.5% of GDP growth A persistent $45 level will cost the US 1-1.2% of GDP growthA persistent $45 level will cost the US 1-1.2% of GDP growth

Dangers Even though high prices are predominantly coming from a booming Asia, from the US perspective, it is a supply problem, not Demand Even though high prices are predominantly coming from a booming Asia, from the US perspective, it is a supply problem, not Demand

Dangers The tight oil market gives Saudi Arabia an extreme amount of power (Saudi Arabia is one of the few suppliers with spare capacity) The tight oil market gives Saudi Arabia an extreme amount of power (Saudi Arabia is one of the few suppliers with spare capacity)

Dangers US consumers are extremely vulnerable. Low interest rates have allowed consumers to spend at a level that has outpaced their income. US consumers are extremely vulnerable. Low interest rates have allowed consumers to spend at a level that has outpaced their income.

Dangers The Federal Government and the Federal Reserve have significantly less “wiggle room” for policy. The Federal Government and the Federal Reserve have significantly less “wiggle room” for policy. The federal budget is already stretched thin with an estimated $500 Billion deficit this year.The federal budget is already stretched thin with an estimated $500 Billion deficit this year. During the 2000 and 2003 “mini-shocks”, we were more concerned with deflation rather than inflation – this gave the fed room to lower interest rates.During the 2000 and 2003 “mini-shocks”, we were more concerned with deflation rather than inflation – this gave the fed room to lower interest rates.