Getting Off the Oil Price Rollercoaster

SOURCE: AP/Rick Bowmer

Swings in oil prices are not only hard on consumers’ wallets and businesses’ bottom lines, but also detrimental to economic growth.

By Amanda Logan | July 9, 2009

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Yesterday’s Wall Street Journal featured an op-ed by Gordon Brown and Nicolas Sarkozy championing the need to reduce the tremendous volatility in oil prices that have taken consumers, businesses, and nations on a ride in recent years. They are prudent to call attention to an issue that, as we described in our recent report, is not only hard on consumers’ wallets and businesses’ bottom lines, but also detrimental to economic growth.

Predictability can be very desirable in the economy, where a more certain future means families and businesses can plan and make financial decisions with increased confidence. Large price swings, however, send confusing signals to consumers and businesses, causing them to delay decisions about purchases and investments. For example, the price of a gallon of gas swung from $4.05 last June to $1.79 in January to $2.63 last month, making it hard to determine where the price of gas will be in another year, and making the purchase of a newer, more fuel-efficient car harder to justify.

Data from the Bureau of Economic Analysis and Bureau of Labor Statistics show that consumer and business expenditures and investments tend to decline the year after a period of large energy price swings, which in turn deals a harsh blow to economic growth. More specifically, following periods of high energy price volatility:

• There is an 83 percent chance that consumers will spend a smaller share of their disposable income on vehicles.
• Consumers buy 1.6 percent fewer vehicles on average.
• There is a 91.7 percent chance that businesses investment in transportation equipment as a share of gross domestic product will fall.
• Businesses purchase 11.0 percent fewer vehicles on average.
• Residential investment declines by an average of 0.5 percentage points relative to GDP.

These declines translate into lower profit rates for and fewer jobs in related industries as well as lower levels of business investment in the overall economy. Reduced business investment spells trouble for productivity growth, or the ability of the economy to get more bang for its buck. And less business investment means that businesses are buying fewer inputs—or components of production—which reduces economic demand and leads to lower economic growth—not exactly a desirable scenario.

High energy price volatility certainly isn’t doing most people any favors, with the notable exception of oil companies, whose profit rates tend to rise during periods of high energy price volatility. Policymakers should therefore seriously consider a range of policies to help reduce energy price volatility, including diversifying our energy sources, promoting investment in and the use of renewable energy sources, increasing energy efficiency standards, and examining the impact of oil futures trading on prices. These actions can’t be implemented overnight, but policymakers can still get the ball rolling to help create an environment that is more conducive to economic growth—in other words, one with less energy price volatility.

Amanda Logan is a Research Associate with the economic policy team at American Progress.

See also:

• Signals on the Fritz by Amanda Logan and Christian E. Weller