Monday, April 04, 2011

Research On Oil Shocks & The US Economy

Don Luskin wrote an interesting editorial in last Tuesday's Wall Street Journal which contained some valuable empirical information on the effects of oil prices on US economic activity.

One of the pieces of research cited by Luskin "suggests that oil prices imperil the economy when they reach a new three-year high."

Another "says the overall economy is threatened when the 12-month average oil price exceeds the year-ago 12-month average price by more than half. Below those levels consumer and investor expectations aren't sufficiently disrupted to make a difference."

Luskin then observed that "both conditions are very far from being triggered at today's prices."

I don't follow the oil markets specifically, so I'll have to take Luskin's word for that conclusion. After all, there are various grades of oil priced at various places, and Cushing, Oklahoma, the standard US pricing nexus, has, I am aware, some capacity issues which can distort prices there.

However, it's pretty clear that today's trailing 12-month average price of oil isn't very high above the prior year-ago 12-month average, although, just typing that reminds me of how much specific price information is required for that determination. Information I don't typically have at my fingertips.

But I do find coherence between the oil effect researchers' approaches to comparing recent prices with year-ago averages or prior peak prices. I've observed similar equity-market-related effects using not entirely dissimilar lagged point-in-time average comparisons. The notion of modeling human behavior regarding surprise or accommodation is not new, and it makes a lot of sense. If changes aren't too drastic over a year's time, people can often adjust to them and, thus, attenuate their impact.

Luskin goes on to cite some more interesting statistics which build upon the US economy's improved energy efficiencies since the first Arab oil embargo of 1973-74. He writes,

"It may come as a surprise to many, but today in the U.S. we're consuming the same amount of crude oil that we did 12 years ago and real output is more than 25% higher. For all the talk of our being the planet's most villainous energy hog, we've become remarkably oil efficient."

Wow. Imagine that! No subsidies for cutting oil usage, and it's become more efficient all on its own. Why, that sounds like a market that responds to price signals, economizing on that which is becoming more expensive, doesn't it?

Maybe oil's price trend and the uncertainty of its level has affected US oil efficiency on its own, without the dubiously-effective subsidies to wind, solar and other ostensible replacement sources.

It is a constant source of comforting amazement to me that US energy efficiency improves over time, on its own, while critics point to simpler, less-useful numbers such as total oil usage. After all, if you have a large economy that creates much economic value, it will tend to use lots of inputs to do so. That doesn't make it bad nor inefficient solely on the basis of scale.

Luskin's piece is valuable, therefore, for two reasons. He highlights some important empirical research suggesting what sorts of oil price increases will be necessary to really cripple the US economy due to consumer behavioral changes, and reminds us that, meanwhile, the country's natural economic behavior has increased the efficiency with which we use this expensive energy input.

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