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What Would Higher Oil and Gasoline Prices do to the Recovery?

By Joe Weisenthal | Tue, 08 February 2011 13:33 | 0

Honestly, oil prices have been moored to around $90 for so long, we're kind of giving up on the whole $100 barrel idea, but obviously a lot of folks think oil is going much higher.

If oil went to $125, what would that do to the recovery?

Barclays' Troy Davig answers. First, two key charts.

One on gasoline prices and the price of oil.

Gasoline prices
Image: Barclays

And second, what higher gasoline prices would do to the recovery.

Real Consumption
Image: Barclays

Here is their analysis:

A steady march higher: The drag of higher oil prices on consumer spending as a starting point in assessing the broader macroeconomic effect of a rapid rise in oil prices, we consider two scenarios in which prices edge steadily higher against a baseline scenario using futures prices. In the next section, we discuss some implications of a rapid spike in prices. Assuming a gradual rise in prices, the first scenario considers a rise in oil prices from their current level of about $90 per barrel to $125 per barrel by the end of 2011, resulting in a yearly average of $110 per barrel.

As Figure 1 shows, we estimate gasoline prices would increase to about $3.90 per gallon by the end of the year. The effect on consumer spending would be noticeable, but not fatal to the recovery. As shown in Figure 2, we estimate consumption growth would be lower, on average, by about an annualized 0.30pp per quarter, but the effect would likely become more pronounced over the course of the year. For example, we estimate growth in Q1 11 to be about an annualized 0.05pp lower relative to our base forecast, but 0.50pp lower in Q4. The fall in consumption is due primarily to the relatively inelastic nature of gas consumption – for example, consumers often must use their vehicles to get to work and have only limited options to substitute for private transportation. So while consumption of gas does fall when prices rise, consumers generally absorb gradually increasing prices by curtailing expenditures in other areas. In the second scenario, we consider a rise to $152 per barrel, with an average of $125 per barrel over the year.

Gas would likely rise to about $4.60 a gallon, and we estimate the drag on consumption growth could be as severe as an annualized 0.60pp per quarter, with consumption rising a mere 1% (saar) in Q4 11. While we see this scenario as unlikely, it would test the durability of the recovery and present policymakers with difficult choices. In terms of inflation, Figure 3 illustrates the effect on headline inflation as measured by the PCE price index. In the most damaging (and unlikely) case, inflation would be accelerating and exceed a 3.0% y/y rate by the end of 2011. On an annualized q/q basis, inflation would be rising at a 4% rate in the second half of 2011.

By. Joe Weisenthal

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