Oil prices and the recession

Written by adam


Economist James Hamilton crunched some numbers and found that the current recession can largely be explained by sub-prime mortgages financial derivatives imploding credit markets insolvent banks winged monkeys the surge in oil prices in 2007 and 2008. It’s a result so unexpected that even Hamilton claims not to believe it entirely, but perhaps we shouldn’t be so surprised. Previous oil shocks in 1973, 1979, and 2000 were all followed by recessions.

The Wall Street Journal weaves the finding into a sort of grand unified theory of the financial crisis:

> Maybe what happened to oil prices had something to do with credit markets seizing up. The housing bubble saw people of lesser means traveling further afield to buy homes. That gave them long commutes that they were able to afford when gas was $2 a gallon, but maybe they couldn’t at $3. Housing in the exurbs got hit hardest, and one reason why is that high gasoline prices made it hard for people to lived in them to keep up with their mortgage payments, and hard for them to sell their homes without taking a steep loss. In some meaningful way, that has to have contributed to mortgage problems.

Other, more complicated theories have been offered. It’s surprisingly difficult to to ascertain the causes of a recession, and I can’t stress enough that Hamilton’s paper is in no way conclusive. In fact, the current financial crisis was almost certainly sparked by an interlocking set of problems.

But it’s worth pulling these threads, because the implications for energy and environmental policy are stark. Environmental considerations aside, we may not want to couple our prosperity to a volatile commodity whose price is only expected to rise in the long term. Matt Yglesias makes this point about as well as it can be made:

> Today’s economy is built on the idea that the atmosphere can safely absorb ever-increasing levels of carbon dioxide, and that ever-increasing quantities of cheap oil can be extracted from underground. Neither, however, is true.

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  1. Jon Kesty

    Thanks to Bush and his oil cronies. I have been saying this for a long, long time. We are an oil based economy.
    What a patriot Bush turned out to be, eh???

  2. Chad

    I have firmly believed that the oil shock of last summer was the pin that pricked the bubble. Recessions follow oil price shocks like clockwork.

  3. dave in kentucky

    If lots more people agree with oil addiction,
    big oil and politician bedfellows, why isn’t there more outcry from a larger number of people and what can we that believe that and want to do something do? We need more than getting to vote for parties that look to me like they are too close to the problem. I’ll believe something is going to change when the larger number of people stand up and demand change. Possibly take charge of each person’s personal life and buy green, buy less of what ” they” want us to, and talk it up to people close to you, even if it gets a row started, take the heat.

  4. Ross

    The fact that we are living in an oil-based economy is not the far-fetched rocket science some would have us believe. Look at other details in line with the Hamilton paper: Fuel goes from $2 – $4/gal. Ok, so your commute budget doubles. BUT, so does your grocery bill, as 90% of the cost of food production and distribution is from energy input (fuel), so does your heating bill, so does the cost of any durable goods, so does inflation, so does electricity etc, etc. all interlinked. Enter in a recession. The greater the energy price spike, the more pronounced the recession.

  5. Dan

    Quit blaming Bush. I love all the people that blame him for everything, even though it takes more than him to do about anything. Even Obama likes to play the blame game. Did your car not start this morning, well, blame GW, surely it’s his fault. We were an oil based economy long before he arrived on the scene.

  6. veeek

    Post hoc, ergo propter hoc — “after this, therefore because of this” is a classic logical flaw, and the article displays it.
    Perhaps the recession’s association with oil is not because oil became expensive, but because America’s economy has intentionally been built on cheap oil’s house of cards, or because of several other reasons (in fact, a simplistic solution is terribly misleading — an explanation should be simple enough but not too simple). Oil at $4/gallon is NOT expensive, certainly not by Japanese or European standards, since those countries have lived with $4/gallon oil for years and have done quite well (in fact, well enough that the world should be looking to them, not the US, for leadership).
    Blaming Bush/Cheney/whomever, although popular, is the equivalent of primitive peoples blaming the stars and is a way to deflect blame from the lifestyle Americans lead. “It’s not our fault, it’s somebody else’s” is a simplistic, circular evasion of responsibility that just gets us back to where we started.

  7. Sean

    Further on Ross’ comment- the rising cost of living associated with fuel costs hurts the poor more than it hurts the rich. For the poor, something has to give. What do you give up? Your mortgage or rent payment, not food, and not gas to get to your job if you have one, or bus fare to the store.
    Oil has become a necessity rather than a commodity. It’s necessary because all forms of commerce rely on it, and oil companies seem to be the only beneficiaries.
    Sadly, we’ve waited too long to change direction, and without a government push to get new technologies going (hopefully with the help of the companies with the most money oil ), we’ll continue in the same direction. Startups have no chance against these companies without the help of tax breaks and subsidies, possibly even through the taxing of current energy companies who are not developing alternative energy sources.

  8. veeek

    Oh, one more comment.
    If we factor in all the indirect costs of “cheap oil” — the tremendous social and economic costs of war-for-oil and petrodollars-to-terrorists, the destabilization of foreign exporters, the environmental effects, and so forth — we have probably been paying far more for oil than 4 bucks per gallon, and we have been doing it for years.

  9. Adam Stein

    Perhaps the recession’s association with oil is not because oil became expensive, but because America’s economy has intentionally been built on cheap oil’s house of cards
    I’m not clear on what distinction is being made here. I’m guessing, though, that the research isn’t based on a simple logical error. Economists are pretty well acquainted with the difficulty of establishing causality in macroeconomic trends.
    Anyway, what the Japanese or Europeans pay for gas isn’t relevant. It’s the price swing that matters, not the absolute cost. Certainly we can imagine a world in which the U.S. isn’t exposed to oil price volatility. Unfortunately, we don’t yet live in that world. Here’s hoping we will someday…

  10. Sean

    Comparing travel (recreational or for work) in the US to travel in Japan or Europe is completely unfair. We do not have the public transit system of Europe or Japan. US civic centers are hundreds of miles apart, compared to countries’ civic centers being less than that in Europe. In the US, having your own vehicle is almost necessary. Not the case in Europe.
    Again, $4/gal gas has a huge effect on people here. I used to work at a tech company just outside Richmond, VA. I live in the city- 18 miles each way. Many large companies in the Richmond area are all spread out in the exurbs, with no public transportation. I rode my bike every now and then, but 36 miles a day is a bit much, especially when daylight gets short.

  11. Jason

    Really, it’s all over priced. In 1981 my dad made $42k a year at his job. His home in Oregon cost $80k. Today, my dad makes $62k a year and his home cost $200k. Something is wrong here. If we cannot afford a home with the jobs that are out there, why are they so over priced? Explain this to me.

  12. Anonymous

    Hello, it’s all been said before and it’s too late to continue to berate the “Bush Administration”..
    I will simply ask this as gas prices rise once again, what ever happened to alternate fuel, electric cars at an affordable price, and wind energy? These items would raise the job levels and reduce the price of a barrel. I guess congress vetoed these, as they still own their gas & oil stocks, as they nixed the construction of schools, roads and levies/dams etc. which would also improve the job market.
    Maybe if they were out of a job they would find it harder to replace the one they have. Something has to be done to get the working people (I talking paverty level) working again, paying their taxes and being able to pay for the gas used to get them to work. Public transportation is still expensive, and/or non-existent.

  13. Lauren

    While, Bush did not help as far as pushing alternatives to fossil fuel, I think that the blame needs to go back much further than Bush. The country as a whole should have changed course back in the 70’s with the oil crisis under Carter’s administration. Blame should be put on all politicians who chose to represent the interest of the oil and car lobbies and instead of the interests of the American people.

  14. Jon

    I DO agree with you wholeheartedly. I remember a college professor saying to me in 1977 that he was growing increasingly alarmed at our growing dependence on foreign oil…1977!!! As a country, we should have bee taking the necessary steps after the ’73 arab oil embargo. I just find the whole thing so sad that the we just don’t seem to do the things that make the most sense and are forward looking.

  15. Tom Harrison

    First, I think this is a good topic, and also some really insightful comments.
    I am inclined to think that oil prices were symptomatic of the larger problems: we love to consume, and we consumed more and more. The 9/11 attacks and subsequent war didn’t help. Around 2005 oil supplies were getting tight, and Katerina was one jolt that made things worse. Our relentless increase in demand (coupled with China’s) kept us on the edge long enough for people to start getting worried. Venezuela and Russia wielded their power.
    Once the predictability of the oil market was lost, it responded as most markets do, and freaked out for a while.
    Oil has this power, as several have said — our whole economy (not just the car) runs on it.
    But rising oil prices were not a cause in my view — they were a symptom of our larger issues with excessive consumption and the great fantasy that we could have more and more indefinitely. The government believed it. The corporations believed it. The financial markets believed it. And most Americans believed it. And yes, it was all enabled by cheap energy.
    Until the house of cards fell down.

  16. Ed Heath

    Of course, we were taking steps after the ’73 oil embargo and the later attempts by OPEC to control the price of oil. We enacted the 55 mph speed limit and CAFE standards for vehicles. But later we raised the speed limit back up, and we failed to increase the CAFE standards.
    As the post says, energy prices, particularly gasoline, are probably not determinative for the recession. But they are a factor, and also probably a good symbol for our life style. As some commenters point out, we spend less on gas than other countries because our government is too cowardly to try to influence our lifestyle, yet an increase in price is enough to contribute to our sharply cutting back on spending, and with that we bring down the whole global house of cards. No wonder Obama is apologizing around the world. But now we need to put our money where his mouth is, and develop renewable sources of electricity and vehicles that use electricity.

  17. Jon Kesty

    Great post, Ed…I couldn’t agree more…