Archive for Thursday, August 18, 2005

Oil price spike not expected to bring repeat of past troubles

August 18, 2005

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— Ouch. Oil is hovering above $66 a barrel and the price of filling up your car is approaching $3 a gallon.

While this year's energy price surge looks a lot like the classic oil shocks of the past that sent the country tumbling into recession, this time a lucky combination of events should spell a different outcome.

That certainly would be desired, since beginning in the 1970s the country has suffered a recession in each of the past three decades that was linked in large part to a surge in oil prices driven by instability in the Middle East.

The biggest difference now, economists say, is that this surge in oil prices is driven by soaring demand for oil, not a sudden cutoff in supplies as occurred with the previous oil shocks.

When the problem comes on the demand side, it generally means that economic growth is occurring at a solid rate, rather than weakening. Problems on the demand side also have less of a negative impact on consumer psychology.

"When oil prices are pushed higher by demand rather than a supply shortfall, people have time to adjust. We just keep on trucking," said David Wyss, chief economist at Standard & Poor's in New York.

A recent AP-AOL poll found that almost two-thirds of Americans expect fuel costs will cause them financial hardship in the months ahead.

But other surveys indicate that most Americans have not scaled back their vacation driving plans this summer nor have they been pushed into greater use of mass transit to get to work even as the nationwide average price for unleaded gasoline hit $2.55 a gallon last week, 68 cents higher than a year ago, according to the Energy Department. Some areas of the country reported prices approaching or even above $3 a gallon.

Merrill-Lynch economists estimate that every penny-per-gallon increase at the pump drains about $1.5 billion out of consumers' pockets. That means the increase in gasoline costs this year has reduced the amount consumers have to spend on other items by about $90 billion.

However, in a lucky break, that drag on consumer spending has been offset by continued low long-term interest rates, which have spurred homeowners to refinance their mortgages and use the savings to boost their consumption.

Officials at mortgage giant Freddie Mac estimate that the amount of cash homeowners will take out of their refinancings this year will total $162 billion, almost double the expected drain from higher energy costs.

That is critical since consumer spending accounts for two-thirds of total economic activity. Any serious cutback in spending because of the higher gasoline prices could quickly crimp overall economic growth.

But so far, analysts said they have seen little indications that consumer spending has suffered from the higher gas prices. They also note that inflation expectations are different this time around.

Oil shocks in the 1970s and 1980s occurred at a time of sharply rising inflationary pressures, prompting the Federal Reserve to respond by aggressively raising interest rates, which had the effect of pushing the economy into recession.

Federal Reserve Chairman Alan Greenspan and his colleagues pledged last week when they pushed the federal funds rate up for a 10th time that they believed they could continue to raise rates at a moderate pace because underlying inflationary pressures have remained well-contained.

That doesn't mean that the higher energy costs have had no impact.

Wyss said he believed the GDP will be trimmed about one-half of a percentage point this year because of the oil spike.

He is predicting GDP growth will come in at a still solid 3.7 percent this year, compared with last year's 4.2 percent increase.

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