Demand the oil price driver, not shortages

Oil spike this time around not expected to translate into the troubles of past oil shocks, driven by instability in Middle East

Martin Crutsinger

Associated Press Economics Writer

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.

Financial hardship expected

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.

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 said the week of Aug. 8 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 percentage point this year because of the oil spike.

“People forget that energy just isn’t as big relative to the economy as it was 25 years ago,” he said, referring to the conservation that has occurred to cut energy usage by both consumers and businesses.