Here I re-tread a well-trodden path, but with recent events in the oil market I thought a brief recap might be timely.
I begin with a photographic illustration of a typical US demand response to the tripling of oil prices that occurred during the first “oil shock” in 1974:
Demand response after a tripling of oil price, USA, 1974
Those long lines of gas-guzzlers were indeed a demand response, but not to the oil price increase. They were a reaction to the nationwide shortage of gasoline caused by the oil embargo that accompanied it. Americans, like George Patton’s tanks during the Normandy breakout, just gotta have gas. And still do.
Fluctuations in oil price, particularly “oil shocks” are nevertheless believed to have had a major impact not only on the US economy but on the global economy as a whole since 1974, and here we will revisit some basic macroeconomic data to see how well this contention holds up.
It’s claimed that oil shocks have caused a number of global recessions, but before we can verify this we have to define what a global recession is. A recession in the US is usually defined as two consecutive quarters of negative GDP growth, but there has never been a universally-accepted definition for a global recession, and according to the annual World Bank GDP data I have to work with 2008 which was the only year since 1965 in which the world economy experienced negative real GDP growth:
Figure 1: Annual global GDP
Fortunately per-capita GDP, which compensates for the population increases that are a major driver of absolute global GDP, is more diagnostic (Figure 2). We now see a series of ramps, with periods of growth separated by periods of no growth. These no-growth periods identify four distinct downturns since 1965 (the downward “blip” in 2001 was caused by unusually high growth in 2000 and goes away when the 2000 data are ignored), and since these downturns seem to define global recessions as well as anything I have used them to define recessionary periods, which are depicted by the gray vertical bars:
Figure 2: Annual global per-capita GDP
Now we will superimpose oil prices on the recessionary periods. Figure 3a compares annual per-capita global GPD with constant 2013 dollar annual crude prices from BP (Arabian light to 1983 and Brent after 1983). Figure 3b, which compares them with quarterly West Texas Intermediate Crude prices gives more detail on short-term price movements, although absolute prices are not exactly the same as those given by BP.
Figure 3: Annual global per-capita GDP vs. (a) BP annual oil prices and (b) quarterly West Texas intermediate crude prices
As Figure 3 shows, and as others before me have noted, each of the four global recessions since 1965 occurred immediately after an abrupt oil price increase, and since the chances that this is coincidence are vanishingly small we can accept that oil price increases played a role, quite likely a dominant one, in all four recessions, including the 2008 “Great Recession”, about which more later.
What other impacts have oil price fluctuations had on global GDP? I have numbered some of the more salient events on Figure 4 and offer brief comments on each below:
Figure 4: Salient economic events, 1965-2013
1. The first oil shock triggers the 1974/75 recession.
2. GDP growth regains pre-1974 levels despite a much higher oil price.
3. The second oil shock triggers the 1980-81 recession.
4. The 1981-82 “double-dip” recession is engineered by US Fed interest rate policy.
5. The oil price collapse of 1985-86 has no visible impact on GDP growth.
6. The third oil shock, coinciding with the Iraqi invasion of Kuwait, triggers the 1991-94 recession.
7. Real oil prices briefly fall back to pre-1974 levels.
8. A “semi-shock” causes growth to fall off in some countries – notably the US (see Figure 6).
9. A tripling of real oil prices between 1999 and 2006 has no visible impact on GDP growth.
10. The fourth oil shock precedes the “Great Recession”.
11. The increasing price trend since 1999.
What these results tell us is that the global economy reacts immediately and violently to abrupt “oil shocks” but doesn’t much care what the oil price does at other times. (As to why the global economy responds only to the “shocks”, my belief is that it’s largely psychological. Like when your faithful and loving dog, who has been lying quietly and peacefully asleep in the corner, suddenly jumps up, bares his teeth and growls at you.)
It also doesn’t take much teeth-baring to send the global economy into a tailspin. The oil shock of 1990-91 increased oil prices by only 50% and lasted for only a couple of quarters, yet it was followed by a global recession that lasted for three years.
Two other key questions are: How long will the upward trend in oil prices that began fifteen years ago in 1999 continue, and is the painfully slow recovery from the Great Recession in Europe a result of high real oil prices? (Note: I don’t have the answers.)
Figure 5 now plots oil price against oil consumption instead of per-capita GDP. It’s similar to the Figure 4 plot, but the impact of the second oil shock now really stands out. Before 1980 consumption was on an upward roll, interrupted only temporarily by the first oil shock. Then between 1979 and 1982 it fell by almost 10% in absolute terms and by about 25% relative to what it would have been had the pre-1980 trend continued. Since 1982 consumption growth has resumed, but at less than half the pre-1979 rate. The growth has also been effectively straight-line, and largely uninterrupted. Even the Great Recession had a muted impact, reducing oil consumption by only a few percent below what it would have been had the pre-2008 trend continued:
Figure 5: Annual global oil consumption vs. BP oil price
There’s also no evidence that oil price fluctuations had any more impact on consumption than they did on GDP outside recessionary periods. Neither the oil price collapse in 1985-86 nor the tripling of oil prices between 1999 and 2007 had any visible impact, although some of the recession-induced consumption decreases, particularly the one during the Great Recession, clearly had a depressing impact on price.
Figure 6 shows XY plots of the annual data from the above Figures. There is no significant relationship between annual percentage changes in oil price and real per-capita GDP nor between annual percentage changes in oil price and oil consumption. There is, however, a relationship between annual percentage changes in real per-capita GDP and annual percentage changes in oil consumption, particularly before 1986, and the relationship is positive, i.e. with consumption increasing as GDP increases. I interpret this to mean that GDP growth is driving consumption, which is the basis for my comments on earlier threads that wealth now generates oil and not the other way round:
Figure 6: XY plots comparing per-capita GDP, oil price and oil consumption
A final word on oil and the “Great Recession”. It’s generally accepted that this recession was triggered by what are now euphemistically called “structural defects” in the financial markets and had little or nothing to do with oil. Wikipedia, for example, gives a long list of potential contributors, starting with subprime lending and the housing bubble, and while it does eventually get around to mentioning oil it doesn’t get there until section 14.8.
Yet immediately preceding the Great Recession in the US, where it began, was another humongous oil price spike (Figure 7. Note that all data are quarterly and that recessions, defined as two consecutive months of negative GDP growth, are shown as blue bars). The leading edge of this spike was at least comparable in amplitude and intensity to the leading edge of the spike that preceded the 1980-81 recession and much larger than the one associated with the 1990-91 recession. The spike also occurred after the approximate threefold increase in real oil price between 1999 and 2007. Between the low of ~$16/bbl in the fourth quarter of 1998 and the peak of ~$125/bbl in the second quarter of 2008 the price of a barrel of West Texas intermediate crude in fact increased by a factor of almost eight in real terms:
Figure 7: US GDP vs. West Texas intermediate crude prices, quarterly data
Surely this is a slam dunk. If oil prices triggered the three earlier recessions then they triggered the Great Recession too. At least one economist agrees. In a 2009 paper presented at the Brookings Institute John Hamilton concluded that “had there been no increase in oil prices between 2007:Q3 and 2008:Q2, the US economy would not have been in a recession.”
And what of the future? At present oil is in oversupply and the oil price is heading south, so barring unforeseen events there doesn’t seem to be much chance of another oil shock in the next year or so. It is notable, however, that oil shocks since 1980 have occurred about once every nine years (in 1980, in 1990, in 1999 if we count the “semi-shock” and in 2008), so we may not be all that far away from the next one.
by Roger Andrews
Source: http://euanmearns.com/ )
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