Sunday, March 4, 2012

How much should we be worried about rising gasoline prices?

That the recovery has taken root is now a well-established story in the mainstream media, so I was going to move on to other subjects but the recent coverage of rising gasoline prices and its economic and political implications seemed to be nearing a hysterical pitch, so I thought I should look into it.

Simply put, there is no relationship between oil prices and economic growth. (Statistics nerds will appreciate that my regression analysis of quarterly changes in real GDP against oil prices from January, 1947 - January, 2012 showed a correlation of 0.08, R-squared 0.006, and a standard error almost exactly the same as GDP's standard deviation. Further, I was unable to find any 10-year period in that span that featured a discernible connection between the two.) This is due in part to the fact that the energy industry is a major contributor to our economy. Beyond that, and perhaps contrary to conventional wisdom, it could be argued at this point rising energy prices are beneficial to our aggregate economic growth because we are once again net exporters of petroleum products. And in the short run it's not hard to imagine that steeply rising gas prices would accelerate the process of people catching up on automobile purchases they had deferred during the downturn.

So what's the big deal? The issue the pundits are wringing their hands over (and just about anyone who's had to buy a tank of unleaded gas understands) is that higher oil prices can divert consumer spending away from the things people really value (e.g., food, shelter, entertainment). But how much? To get an idea, it's helpful to look at energy spending's place in our collective household budgets and how that's changed over time:

A couple of observations:

1. There is a distinct long-run downtrend of energy's role in our budgets. This is consistent with the notion that over time we've become more efficient energy consumers.

2. The two big deviations from the trendline relate to the two most significant periods of oil price volatility: roughly 1974-1986 and 1999-now. The 1974-1986 period pretty much follows the same contour as oil prices, indicating that the oil price changes didn't affect our energy consumption as much as it crowded out spending on other things. This is the kind of painful displacement that political pundits think could derail Obama's prospects.

But a closer look at what's been going on since 1999 reveals a different story:

The period begins at 4%, the lowest level on record, peaks at 7% in 2008 (when oil spiked to almost $140/barrel) and ends at about 5.5%, just above the 5.25% average for the period. While the line broadly tracks oil prices, the slope tends to be much more gradual. This is very different from what we saw during the oil price shock of the 1970's.

Consumers' budgets are clearly less sensitive to oil price swings than they used to be, and there several reasons, including our diversification of energy sources (natural gas recently became the #1 home heating fuel) and efficiency improvements to our transportation. But perhaps most significant is the simple fact that we don't drive as much as we used to:

This chart shows per capita miles driven in the US since 1970. It's easy to see that we've driven fewer miles on average since the 2004 peak, but it's also noteworthy that the rate of growth prior to then was declining, too. In the 1970s and 1980s, per capita driving was growing at a 2.4% average annual rate, but the rate shrank to less than half that in the 1990s and up until the 2004 peak (1.15%). I could only guess as to why, but it's reasonable to imagine that it's at least partially due to the proliferation of the internet - there is so much stuff we do online that our parents used to have to leave the house to do (banking, shopping, working, etc.).

All of this is just to say that fears that a spike in gas prices will sink either our economy or Obama's prospects are way overblown. There is no evidence that higher energy prices actually damage our economy, and while no driver likes to see higher gas prices, it's not as big a deal as it used to be.

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