Weekly Economic Trends and Indicators
As the saying goes, “oil is the lifeblood of the economy.” Oil is the fundamental raw material necessary to fuel the transportation that moves goods to market. Without oil, the world’s ships, airplanes, trains, and trucks would grind to a halt.
Personal transportation also depends on oil. While electric cars are becoming more popular, the majority of cars on the road in the U.S. run on gasoline. (Plug-in electric vehicle sales are expected to reach nearly 14% of new car sales this year.) As a result, the price of gasoline is one of the most closely watched prices in the economy. When the price of oil rises, so does the price of gasoline. That leaves people with two choices: drive less or pay more.
Economists have a technical term called “elasticity” that describes consumers’ response to price changes, but one outcome is both reliable and easy to explain in non-technical terms. In the short-term, people will change the amount of gasoline they buy only by a small amount, and they will pay more out of their pocket. However, the longer the price remains high, the more people will substitute away from gasoline. They will cut down on discretionary trips, carpool to work, or if the incentive is strong enough and lasts long enough, buy a more fuel-efficient car. Yet even after making these substitutions, the negative effect on their budget will likely be large enough to cause them to cut back in other areas of spending. If the drop in spending is large enough, it could lead to recession.
We experienced this in the 1970s when oil prices jumped due to a series of crises in the Middle East. The rise in oil prices was sustained for a period of years, and in fact, never returned to pre-1973 levels. Then from the mid-1980s to the late-1990s, there was relative calm with only one sudden spike in 1990 in connection with the first Gulf War. This was, in fact, associated with the recession of 1990-91.
Since the year 2000, however, oil prices have been much more volatile. The most recent oil price spike was in late 2021 and early 2022 around the time of the Russian invasion of Ukraine. The price of a barrel of West Texas Intermediate crude oil rose from $66.39 to $123.64 (86% increase) over a period of 95 days. With the sharpest increase of 35% occurring over 11 days in February and March 2022. In the last month, we saw an even faster increase (45%) over 11 days (Feb. 26 to Mar. 9) as the price rose from $65.10 to $94.65.
Gasoline prices have followed suit. After reaching the lowest price in 5 years ($2.779/gal. national average on Jan. 12), the national average reached $3.990 on Mar. 30, the highest since August 2022.
In 2022, the price remained above $80 for over nine months, and much to the surprise of many analysts, a recession did not occur. We are now only one month into the current market disruption, but the dynamics appear to be very different. The primary factor causing prices to rise is the disruption of traffic in the Strait of Hormuz. If a resolution to that problem can be reached, we should expect the price of oil to fall, perhaps as quickly as it increased. Of course, it may remain somewhat elevated for as long as geopolitical instability remains.
If the flow of oil through the Strait of Hormuz returns to normal levels in weeks rather than months, a recession would be unlikely. If consumers believe that this is temporary, they are less likely to change their spending habits. For the moment, the U.S. economy is strong enough to withstand a temporary disruption such as this, although it could shave a few tenths of a percent off of GDP growth if it lasts for more than a couple of months. If, for whatever reason, the price of oil were to remain significantly elevated for an extended time, recession becomes more of a concern.
Next week: U.S. employment report
