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Home Publications Blogs Beat the Press The Impact of Oil Prices on Economic Growth

The Impact of Oil Prices on Economic Growth

Thursday, 24 February 2011 05:26

An NYT article discussing the impact of higher oil prices on the economy told readers that:

"As a general rule of thumb, every $10 increase in the price of a barrel of oil reduces the growth of the gross domestic product by half a percentage point within two years."

There is no source cited for this rule of thumb, which implies an extraordinarily large impact of oil prices on GDP. For example, the fall of oil prices from an average of $91 a barrel in 2008 to $53 a barrel in 2009 should have added almost two percentage points to GDP growth in the last two years.

The article later gives a more conventional rule of thumb, that each 1 cent increase in gas prices takes $1 billion out of consumers' pockets. These two rules of thumb appear inconsistent. A $10 increase in the price of a barrel of oil would imply an increase in gas prices of about 25 cents. This would reduce the money available for other consumption by about $25 billion a year. If the impact is doubled to account for other uses of oil (e.g. home heating, electricity, etc.) this would reduce the money available for spending by $50 billion, approximately 0.3 percent off GDP.

Of course the reduction in spending will not be 100 percent of the higher price of oil, many consumers will dip into their savings, just as they would in response to a temporary tax increase. In addition, some of the gain from higher oil prices goes to U.S. producers of oil, either as domestic production or importers with higher profits. While higher earnings for producers will have less impact on increasing spending than higher oil prices will have on reducing spending, the impact will not be zero.

On net, it is unlikely that the actual impact of a $10 increase in the price of a barrel of oil would be even half as large as the rule of thumb described in this article. A substantial rise in the price of oil would still have a substantial impact on the economy, but not nearly as much as this article claims.

Comments (4)Add Comment
written by izzatzo, February 24, 2011 5:16
In contrast to pointy pinheads like Baker, Teabagger Elasticity Experts of America report that due to excessive government regulation that suppresses oil production in the USA, the cross-price elasticity of foreign oil with domestic oil exceeded unitary elasticity when ANWAR drilling was prohibited and created a huge negative income effect from the drain of revenue to foreign oil that caused the deep recession. It wasn't reduced wealth from the housing bubble after all.
written by Clive, February 24, 2011 8:57
Rising Oil Prices and Recessions
written by Tony, February 24, 2011 6:50
Stephen Leeb in his research has shown that you need a double in oil prices in less then a year to have a negative effect on our economy. This has happened six times since 1970, and five out of six we had recessions. They were in 1973-1975, 1980-1982, 1990, 2001, and 2008 with 1987 being the only time we had a double in oil prices in less then one year without a recession, but just a severe bear market. To say oil has risen high enough to probably cause a recession is one thing, but I agree with Dean here that trying to figure out how much every dollar increase in oil prices will effect consumer spending is another.
written by Derek, February 24, 2011 11:01
They probably dusted off this "rule of thumb" from the 70s (or late 90s), when going from $10 a barrel to $20 a barrel might have had that effect. Going from $90 to $100 a barrel isn't going to be as much of a shock.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.