Falling Gasoline Prices: Good or Bad?

James’ previous post on this looked at the falling gasoline prices and argued that it is a good thing for President Bush as the midterm elections approach. I even pointed out that this news, coupled with additional news about the economy slowing down could mean good news in terms of the Fed and rising interest rates.

Now James Hamilton has posted on the declining gasoline prices and notes something very interesting.

What will this mean for the economy? The economic damage of recent high oil prices so far has been milder than I had anticipated, leaving me to be cautious about predicting too big an economic boost from these anticipated price drops. I have long maintained that to the extent that booming demand was the primary factor bidding oil prices up, that reflects positive, not negative, economic fundamentals. But the reverse dynamics appear to be in play at the moment– the incipient economic slowdown is likely a factor in the recent weakness in oil prices, and that, in itself, is bad news, not good.

This might seem somewhat counter intuitive to some. The basic idea here is as follows,

  • If gasoline prices are rising due to increased demand due to improved economic conditions, then this is actually a good thing in that it means an improved economy.
  • If the above is true, then a decline in oil prices implies a decline in economic activity–i.e. the economy is not improving and may even be declining.

So, while the decrease in gasoline prices is a good thing in terms of the consumer’s expense on gasoline, it may not be really great news in that it could be a result of the economic slow down which could mean higher unemployment, slower income growth, etc. Or as Prof. Hamilton puts it,

Three cheers for falling gasoline prices? At least one, yes, but you might want to keep a couple more in reserve as we wait to see how this plays out.

This strikes me as the right take on the situation.

FILED UNDER: Economics and Business, , , ,
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. RiverRat says:

    Seems like spin to me. The easy question you should answer in reponding to this is the decline in gas prices a result of declining demand and reduced fear of supply disruption, is it the result of increased supply and reduced fear of supply disruption, or is just the result of decreased fear of supply disruption?

    Is it just the end of the summer travel season reducing anticipated demand? Or is it really economic slowdown? Job growth was greater than anticipated. Doesn’t sound like economic slowdown…yet.

  2. The rate of growth in gas consumption has declined. Is this from a weak economy or simple supply/demand reaction to higher gas prices? I would suspect the later.

    That being said, I think at a minimum no further increase in the interest rate makes sense if not easing back on it by a quarter point. But that is not because gas prices are coming down.

  3. Steve Verdon says:

    Spin? Okay, now thanks I know you aren’t serious about this.

  4. Herb says:

    The drop in oil and gasoline prices, as I predicted and thought all along is happening.
    The economy has dropped with retail sales dropping and has resulted in last weeks drop in stock prices. ( and no interest rate hike) I have always said that when the big money boys on Wall Street started to feel the pinch, they would put the screws to the oil price manipulation going on at the NYMEX. Also, there is an election just around the corner and the Republicans wouldn’t stand a chance if gasoline prices remained high. I said that the “Next Election would be decided by the price of a gallon of gasoline” and I was told by Steve V. “I didn;t know what I was talking about” while He continued to make excuses for big oil.
    Supply and demand, That’s the biggest excuse that is used and when a large supply was in stock, the excuse was some other excuse used.

    What the low price boils down to is that big oil stuck its hand into the wall street big money boys pockets a little to deep and the Republicans want a better chance at the polls.

    Those reasons and those reasons only are why oil is drooping in price.

  5. AW says:

    The price of oil and gas has been artificially high due to tensions in Iran/Iraq, supply disruptions in other areas (Niger, Canada), and fear of storms like Katrina.

    I agree that if prices are falling because the economy is cooling that may not be a good thing. But employment and other economic stats are still pretty good.

    In sum I would ascribe it to supply/demand factors and some pricking of the speculation bubble which are both good things.

  6. Steve Verdon says:

    I agree that if prices are falling because the economy is cooling that may not be a good thing. But employment and other economic stats are still pretty good.

    Unemployment/employment are lagging indicators. That is, they will show signs of a recession after the recession starts, not before.

  7. Bithead says:

    To measure your theory, however, Steve , you need to apply here theory to other commodities. For example, let’s take the cost of food, and over. And of six months raise it by a third. Do you suppose going to have an adverse effect on the economy in the overall?

    I think we both know it will.

    The reason the economy is slowing down, was because fuel prices were through the ceiling.

  8. McGehee says:

    As YAJ points out, no one can make a serious argument about the state of the economy solely based on the current trend in gasoline prices.

    Rising prices will reduce demand, even for something as “inelastic” as fuel. There is a considerable amount of play in fuel demand in a highly prosperous economy, which can see demand reduced significantly when nonessential consumption begins to cut into the ability to take all four kids to Six Flags over Labor Day weekend (research how much admission costs at a Six Flags park — for most people here in Georgia, it’s still a damn sight more than the gas it takes to get there).

    Such decisions will, admittedly, translate into a downtick in economic figures — but in terms of standard of living it amounts to using the discount brand of mayonnaise instead of Hellmans.

  9. Bithead says:

    Rising prices will reduce demand, even for something as “inelastic” as fuel.

    It isn’t even quite so direct.

    Increased fuel costs, assuming they are inelastic as you suggest, means that money isn’t going to be spent elsewhere.

    Example; a goodly chunk of our economy right now is driven on travel and tourism. My travel trailer set for a good number of days that it should not have, were fuel costs in line with reality. Do you suppose that affected the economy of the areas I would have visited?

    How many home improvements didn’t get purchased because the consumers knew they would need the money to pay for fuel to get back and forth to work?

    How many new cars didn’t get bought, because of increased fuel costs?

    How many business trips didn’t get taken because of increased costs as regards flying? (To say nothing of the increased hassle as regards security, which is another matter which is, like Fuel costs, indirectly tide to Middle East instability )

    All of these add up to an economic downturn. All of them are related to the cost of fuel.

  10. Herb says:

    Bithead:

    You are right on and have the entire thing figured out, however you are trying to make a point to someone who deals in “Theories” and not the reality of the real world.

    The cold hard facts remain:
    1. Prices are higher on most everything due to increased shipping cost brought on by high fuel prices.

    2. Wall Street is feeling the pinch of high fuel prices and suffering a lower market.

    3. There is an election around the corner and if the Republicans want a chance, lower fuel prices are a must.

    Any other “theories” are just that Theories”, which are nothing more than a guess by those who fail to realize “Reality” and try to explain things with X’s and Y’s, which are used to symbolize the male and female gender.

  11. Bithead says:

    And once again, I’m left with the voice of eorge Soros in my ear, telling Americans he was going to manipulate the price of energy, specifically oil, so as to make the current administrtaion look bad.

    Remember?