Falling Oil Prices May Spell Relief For Consumers?

By: Paul Kasriel | Thu, Sep 14, 2006
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This was the headline (sans question mark) of the front-page, right-hand column in today's WSJ. Yes, falling oil prices are a relief for consumers. But before we start marking up our GDP forecasts too much and call off Fed easing, let's try to analyze why oil prices are falling. Is it because the supply of oil has increased of late or is it because the demand for oil has decreased. And, if it is because the demand for oil has decreased, why has it done so?

Although Chevron has made a major oil discovery in the depths of the Gulf of Mexico, it will be years before this supply is available. In the meantime, BP has cut production in Alaska because of corroded pipelines. So, it does not appear that the recent decline in oil prices is a supply-side phenomenon.

Have geo-political conditions with regard to the Persian Gulf calmed down? Not really. Stability has not broken out in Iraq and Iran has not acquiesced to U.S. demands. Is the hurricane season over? No, it still has about six weeks to run. So, it does not appear that the precautionary demand for oil inventories has declined.

Perhaps oil prices have declined because overall aggregate demand in the U.S. is growing more slowly. If that were the case, then not only would oil prices being showing weakness, but so would the prices of other economically-sensitive commodities. Any evidence of this? Of course there is or I would not have brought it up. Chart 1 shows that the price of copper scrap has fallen from a cyclical peak of $3.42 a pound in mid June to about $2.58 a pound currently. Is it just coincidence that copper prices are retreating at about the same time as oil prices or could there be some common cause? And Chart 2 shows that the volume of our energy-related petroleumproduct imports on a year-over-year basis has actually contracted in the first-half of this year - a period when aggregate domestic demand has been moderating too.

Chart 1

Chart 2

So, there would appear to be more evidence supporting the demand-side explanation for the recent decline in oil prices than the supply-side explanation. If it is weaker demand that is explaining lower oil prices, then do not look for a rapid re-acceleration in consumer spending or domestic spending of any sort. To be sure, a decline in energy prices will lead to stronger consumer spending than otherwise would be the case. But this would be a second-order effect if the decline in oil prices is the result of a restrictive monetary policy.



Paul Kasriel

Author: Paul Kasriel

Paul L. Kasriel
Director of Economic Research
The Northern Trust Company
Economic Research Department
Positive Economic Commentary
"The economics of what is, rather than what you might like it to be."
50 South LaSalle Street, Chicago, Illinois 60675

Paul Kasriel

Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005. The accuracy of Paul's 2008 economic forecast was ranked in the top five of The Wall Street Journal survey panel of economists. In January 2009, The Wall Street Journal and Forbes cited Paul as one of the few who identified early on the formation of the housing bubble and foresaw the economic and financial market havoc that would ensue after the bubble inevitably burst. Through written commentaries containing his straightforward and often nonconsensus analysis of economic and financial market issues, Paul has developed a loyal following in the financial community. The Northern's economic website was listed as one of the top ten most interesting by The Wall Street Journal. Paul is the co-author of a book entitled Seven Indicators That Move Markets.

Paul began his career as a research economist at the Federal Reserve Bank of Chicago. He has taught courses in finance at the DePaul University Kellstadt Graduate School of Business and at the Northwestern University Kellogg Graduate School of Management. Paul serves on the Economic Advisory Committee of the American Bankers Association.

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