The Impact of Oil Prices on Economic Growth

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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.