Argonne Economist Predicts Gas Price Bump and Following Recession: Part 3

Will There Be a Recession?

"There is a cumulative pressure that builds when people have to spend a lot on energy," Santini explained. "People will postpone car purchases, tires and repairs for instance, and rethink buying new home appliances."

Full calendar-year declines in gross domestic product have usually followed positive oil-price shocks, even the mild ones of the 1950s. Data are from the Bureau of Economic Analysis and the Survey of Current Business.

Combined with the well-known patterns of slow growth of the money supply and rising interest rates, this typically combines to cause a recession. "And the sector most dependent on oil — the transport sector — shows the sharpest decline in output," Santini said.

One factor may mitigate against a recession. In several of the recessions since World War II, the government required significant safety or emissions regulations that drove the price of cars up as oil prices rose. This added to the decline in vehicle sales. "We don't have that this time," he noted.

Also, motor vehicles and gasoline operating costs are a smaller portion of national income than in the past. "Many economists used this argument to downplay this oil price shock before concern over a recession became widespread," Santini said. "Nevertheless, this has been a very significant price shock, and the coincident winter increases in natural gas prices have been a problem, as are the electricity supply shortages in the West."

What will happen?

Americans love their SUVs, like the Ford Expedition (right), even though fuel-efficient vehicles like the Honda Insight are available.

"What is happening now is reminiscent of the 1970s and 1980s," Santini said. The difference is that the United States is now more dependent on Middle Eastern oil than it was in 1973, but the reasonably rapid decreases in dependence after an 1988-1990 oil price shock serves as a reminder to Middle Eastern producers that oil alternatives are available. In the latter case, the percentage of oil imported from the Persian Gulf dropped from 11.6% in 1990 to 8.8% in 1996.

As the 21st Century opens, Santini admits that his model may work only for oil in the 20th Century. "It is possible that the model may not apply to the full 21st Century as the importance of the transportation sector slowly diminishes as the service sector grows," he explained.

"My model implies that sustained high prices are more likely than suggested by the models that investors are using to set futures prices," Santini said. "It will be more difficult this time to reduce oil use than it was in the 1980s, since transportation is responsible for a larger share of our oil use. And it is more difficult to reduce oil use in transportation than in residences, businesses, industry, or electric utilities.

"Despite the fact that our percentage of the world oil market is now much lower, I believe that how the United States manages its energy production and consumption will still continue to have a very strong effect on the world market," Santini said.

Diagnosis for a Healthier Energy Future

Americans should show more interest in fuel efficiency at times when fuel prices are low and supply seems abundant, Santini believes. "Fuel prices are among the most volatile of all prices, and repeated fuel price shocks that slow or reverse economic growth have actually been typical of the U.S. economy for two centuries now," Santini advises.

The United States has a large supply of both oil and natural gas. It was the first country to aggressively exploit its abundant domestic supply, but it will also be one of the earliest oil-rich nations to use up its domestic supply. "It is slowly but steadily becoming an energy-poor nation with respect to these two fuels it values highly," Santini said.

To create a more stable economy, Santini suggests that the United States should begin adapting its behavior as have energy-poor industrialized nations such as France, Japan, and Germany. Those nations combine higher fuel taxes and more fuel-efficient technology.

By following the example of these other nations, the U.S. economy could be less susceptible to the effects of future world oil price shocks since the impact of such shocks would be diminished. These actions, Santini hopes, could cut the chances of shocks happening at all.