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Will high oil prices hurt the recovery—or help it?

at 12:40 PM ET, 02/16/2012

These days, the U.S. economy’s looking rosier, with one exception: oil. Crude prices are ticking past $100 per barrel — thanks, in part, to tensions with Iran — and gasoline remains pricey. That, in turn, could imperil the recovery. But let’s see how this might happen.


Workers load equipment onto a truck to be transported to a ship for a delivery to oil rigs in Malaysia. (Bazuki Muhammad - Reuters)
The conventional story is this: If U.S. consumers are spending more on gasoline, all that money gets spirited to overseas producers. Consumers have less funds for other purchases, which hurts the recovery. Manufacturers, too, see their profit margins sliced. The standard rule of thumb is that a $20 increase in the cost of a barrel of oil — roughly what we saw in 2011 — shaves about 0.4 percentage points off growth and boosts unemployment by 0.1 percentage points. Put another way, last year’s price increase cost the United States about $125 billion, which would be enough to negate the effects of the just-agreed-to payroll tax holiday.

But not everyone’s so gloomy. Economist Karl Smith, who’s generally been bullish on the recovery, observes that higher oil and gasoline prices might ripple through the economy in a variety of ways. On the bright side, higher prices could cause more investment in domestic oil drilling — remember, the oil and gas industries have been a significant driver of the current recovery — and they could also spur many consumers to swap out their old, inefficient cars for new ones, boosting auto sales. “So,” he notes, “its hard to say even if higher gas prices are contractionary or expansionary.”

Then again, there’s also the Federal Reserve to consider. As the Wall Street Journal points out Thursday, an oil shock could make the central bank jittery about rising prices, even if it’s only temporary inflation. That, in turn, could complicate the Fed’s willingness to stimulate the economy. Does another round of quantitative easing become less likely if oil prices keep nosing upward? “In the past,” the paper explains, “the Fed has been willing to look past temporary spikes in inflation, but it isn’t clear it would be willing to do so again.”

As ever, there are plenty of complicating factors at play. A slowdown in China could ease the pressure on oil prices. The mild winter means that consumers in the Northeast have to spend somewhat less on heating oil. Low natural gas prices are holding down resource costs for many companies. And, as discussed in this post, Americans have been driving less and buying more fuel-efficient cars as higher gas prices become the new normal (each year since 2008 has seen a growing share of days with gas above $3 per gallon). So there’s no guarantee that pricey oil will squelch the economy. But it’s certainly a big factor to watch.

 
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