Over $50/Barrel for Oil, but No Recession?

In the 1970s, tumultuous foreign affairs sent oil prices sky-rocketing, driving the US government to set an oil-price ceiling and driving Americans to madness in epic lines at the gas pump. But the worst part of the oil crises was the protracted recession they induced. Today, oil prices are ever higher, over $50 per barrel, yet (aside from sluggish growth) it's clear there's no recession. Whew! we may sigh, but why?

The Federal Reserve Bank of San Francisco offers an answer: the source of prices is the answer. As opposed to the exogenous factors of the 1970s, current high oil prices are primarily due to steadily increasing domestic demand. In short, the steep cost for consumers reflects economic activity within the economy, people are going places and doing things that expand the economy. To be sure, the rising energy costs are painful to businesses, who might otherwise invest more capital, and consumers, who might otherwise spend more. Since these high prices reflect high demand, the upward inching numbers at the gas station indicate that consumers are willing to pay more because it's worth more to them. However much it costs for gas, they're gaining a greater economic advantage in spending for it.

This may not placate friends and family who will nonetheless whine as we drive into a gas station, but hey, I tried. If you seek a more technical discussion, check-out economists' views (such as at Economists' View and Bradford DeLong) or read the actual Fernald & Trehan paper. Here's a snippet:

But much of the run-up in oil prices in the past few years seems to reflect the endogenous response of prices to the strength of global demand. The source of this higher demand turns out to be important. If the higher prices were the result of higher U.S. demand, then there would be little reason to fear a recession. It is hard to believe that the "tax" imposed by the oil price increase would exceed the increase in income that was the cause of the higher oil demand. But if the increase in demand originates abroad, things get more complicated. For instance, high oil prices which reflected rapid growth in China would have the same direct impact on the U.S. as a price increase engineered by OPEC, basically because higher oil consumption in China coupled with a relatively inelastic supply means that less oil is available to the U.S. There is a potential offset to this effect, as more rapid growth in China is likely to be accompanied by higher imports. Thus, countries that export significant amounts to China relative to their size will benefit from the rapid Chinese growth. The U.S. is not one of these countries, however, so that for the U.S. an increase in the price of oil due to higher demand from China is probably similar to an increase due to a reduction in supply.