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April 08, 2009
| Causes and Consequences of the Oil Shock of 2007-2008 | Economy Energy Peak Oil |
James Hamilton at Econbrowser has two posts summarizing a paper he presented at Brookings dealing with causes and consequences of the oil price shock of 2007-2008. Interesting reading.
On causes, he calculates that the runup in price was consistent with reasonable assumptions about oil demand and its elasticity. Elasticity is a measure of how strongly demand responds as price changes. For a product like oil, which has no short-term substitute and which is used in ways (like driving to work, heating a home, generating power) that people are highly reluctant to forgo, the elasticity is quite small. Which is to say, it takes one hell of a price increase to get people to consume less, especially in the short term. (In the long term, people may switch to smaller cars, and so on. Hamilton says that kind of long term adjustment may even help explain why prices have fallen as far as they have.) Worldwide GDP growth between 2003 and 2007 was such that at existing prices worldwide demand would have been greater than worldwide production, which had flatlined. Rising prices were the result. They kept rising until enough people were priced out of the market to equalize supply and demand. A speculative bubble in oil futures may have contributed to the price spike, but Hamilton's calculations show that it could have easily just been (mostly) your basic supply-and-demand story.
On consequences, he calculates that the impact of sky-high oil prices on the global economy may have been a significant factor in starting the recession that has now become such a vicious downturn. There was a debt bubble for sure, but it may have been the oil shock that pricked the bubble.
People tend to take cheap energy for granted, so we routinely underestimate the extent of its role in the economic fortunes of the modern world. Now that oil prices have fallen so drastically, exploration and new drilling have ground to a halt. Without new sources of supply, depletion will soon erase whatever supply cushion may exist at the moment. So the world is setting itself up for another big price shock when the economy eventually picks up and demand starts to recover. The world economy may get another big kick in the head just when it is trying to get back onto its feet.
Posted by Jonathan at April 8, 2009 10:16 PM
Comments
Good post, well summarized, 100% correct.
Posted by: Wolf DeVoon at April 8, 2009 11:00 PM