Earlier this week, one of the lead economic correspondents from the New York Times tweeted a story from the NYT with the headline “US Economy is Better Prepared for Rising Gas Costs.” (http://www.nytimes.com/2011/03/09/business/economy/09gasoline.html). On its face, it seems reasonable enough – we’ve been facing high oil prices during much of the last decade, so to a certain extent we should have adjusted behavior.
The article cites a few facts and anecdotes, some of which counteract this point and some where the factual information has little basis. First, the authors note that many drivers have “given up their gas guzzling sport utility vehicles. Automakers, which are selling more fuel efficient cars than five years ago, reported higher sales in February even as gas prices rose.” The writers even go on to cite cash-for-clunkers as a factor later in the story. The problem with this logic should be obvious: there are over 250 million passenger vehicles in the US, and cash-for-clunkers retired a whopping 690,000 of those or, about 0.2%. The truth is that cars stay on the road for around 15 years, so the increase in fuel efficiency of new cars over the last couple of years has barely made a dent in the average stock efficiency.
Since the stock efficiency has not changed enough to make a difference – consumers have three choices in response to higher prices: drive less, reallocate income towards oil (and away from other goods), or dis-save. Next you get a few anecdotes from the NYT, telling “precisely” how consumers have changed their behavior: Tival Williams, has apparently dumped his SUV for a Mazda CX-9 and is saving $30 a week, we are told. But we don’t hear about the person who bought Tival Williams SUV; apparently he was happy about the bargain he got on it, and is using the money he saved on the deeply discounted SUV to pay for the extra gas it burns.
Next in the NYT anecdote arsenal is Ronnie Undeberg, who has started “planning errands” – this is known in the energy demand world as trip chaining, and is a strategy to reduce gasoline consumption. Trip-chaining, along with car-pooling and reducing discretionary travel are ways that consumers always respond to oil price increases in the short-run. Without doubt the last decade of oil price run-ups must have made us collectively better at changing our behavior in response to high oil prices than we used to be. But we should not equate this to the US economy as a whole being less susceptible to rising gasoline costs, as the article title implies. As a whole, consumers have historically only been capable of changing driving behavior enough to absorb at most 20% of the price increase in the short-run. So that along with the couple percentage points of increased stock efficiency through cash-for-clunkers and other inefficient vehicle retirement still leaves a heavy price burden that consumers have to accommodate somehow.
The mechanism for absorbing the remaining 80% of the price increase burden is through dis-saving and expenditure shifts, and the same Ronnie Undeberg tells us that is exactly his next step, stating that he’d scale back his cable television and cut his cellphone use if gas went up to $4 per gallon.
Dis-saving is not an option for a current portion of Americans right now, so like Ronnie, many people will be reallocating expenditures. Because of this, more money will be reallocated from cellphone and cable television and likely many other goods and services with a significant domestic component. This reallocation of expenditures to oil must slow down the recovery (there are some positive secondary impacts due to petro-dollar cycling, particularly into the capital account, but these also can’t entirely counter-act the expenditure reallocation. See more here: http://www.newyorkfed.org/research/current_issues/ci12-9/ci12-9.html)
There’s an additional factor that I think may worsen the impact of the current price increase on our economic recovery. The unemployment rate is currently still over 9%, and for the unemployed a higher % of their driving has become discretionary and thus the reduction in travel component must be a factor in holding down current oil demand. I ran a quick regression and found that unemployment rates over 6% combined with increasing oil prices serve to reduce passenger vehicle travel (VMT) by 50% more than high prices alone. So during this recession where prices are rising, US consumers have likely curtailed demand more than they would have if unemployment had been lower. As hiring picks up over the next year or so, the newly employed will have to reactivate their gasoline purchases; thus the virtuous cycle between increased employment and increased consumer spending may be dampened by the high gasoline prices. The recovery will be more sluggish.
The NYT article seems to understand this, quoting an economist who says “high oil prices always hurt our economy” and making the point that “higher fuel costs reduce consumers’ discretionary income, which is often spent on such niceties as dining out or the latest electronic devices.” Somehow, these points become not central to the main thesis of the article.
So is the US economy better prepared for high oil prices? From what I can see, the economic impact of high prices is going to be just as bad, it may just happen more quickly since consumers have practice in reacting to high prices, and a…