66 Finance & economics The Economist March 12th 2022
Shockabsorbers
T
he omensare bad for the world economy. When oil prices
surge, growth typically moves in the opposite direction. Some
times the price shock begins with a political earthquake, like the
Suez crisis of 1956. Sometimes oil producers deliberately create the
shock, as with the opecembargo of 1973. And sometimes the cul
prit is soaring demand, such as when oil prices hit record highs in2008. The common denominator in all these cases is that America
and most other rich countries soon enough faced recessions.
So it would hardly be surprising if the current surge in oil pric
es—a doubling in three months, fuelled by Russia’s invasion of
Ukraine—foreshadows a sharp downturn in growth. Pictet, an as
set manager, counts six episodes since 1970 in which real oil prices
rose by more than 50% from their previous trend; each preceded a
recession. As of late February oil prices had already surpassed this
50% threshold, and have only climbed higher since then.
Nevertheless, the easily observed relationship between oil and
the economy is no iron law. There have been times when crude
prices soared and yet recessions were averted, including the peak
of a global commodities boom in 2011. The type of shock matters,
as does the economic backdrop. Moreover, much of the world ap
pears to have become better insulated from oil markets over time.
Old dismal patterns may not perfectly repeat themselves.
Consider the mechanics by which rising oil prices hurt growth.
Energy is an important factor of production, so a sharp decrease in
its supply or increase in its price may drag down output. It may al
so hurt demand: if people spend more of their incomes on oil, less
is left over for other things. Add to this the possibility that central
banks may tighten monetary policy aggressively when higher oil
prices push up inflation, as the Federal Reserve did following the
opeccrisis of 1973 and the Iranian revolution of 1979.
Yet no two oil shocks are the same. A critical variable is wheth
er the shock stems from the economy’s supply side or demand
side. If there is a sudden shortfall in supply, as during an embargo,
that functions as a new tax on production and consumption. If,
however, robust demand is the cause, rising oil prices reflect eco
nomic vitality. Lutz Kilian, an economist with the Fed’s branch in
Dallas, has shown that broad demand strength can, for a time, out
weigh the negative effects of higher oil prices. A pure supply shock
is, by contrast, more harmful. The period since the pandemic
struck has featured a bit of both. The quadrupling in crude prices
from the spring of 2020 to the start of 2022 reflected growth roar
ing back from its pandemicinduced slowdown. Only the most re
cent surge is unquestionably a supply shock, caused by the Uk
raine war and associated sanctions.
Three changes in the structure of the global economy may
dampen the effects of the price surge. Most obviously oil’s role in
growth cycles is not what it used to be. In 1973 the world used near
ly one barrel of oil to produce $1,000worth of gdp(in inflation
adjusted terms). By 2019 that was down to 0.43 barrels, with the
energy intensity of growth falling annually “in an almost perfectly
linear fashion”, according to a report last year by the Centre on
Global Energy Policy at Columbia University. A shift in economic
output from industry to services is part of the explanation. The
world has also become more efficient in using oil. Cars, for in
stance, go twice as far per gallon of petrol as in the 1970s.
A related change is the way that governments respond to oil
shocks. As James Hamilton of the University of California, San
Diego, has observed, in the 1970s American officials aggravated
economic dislocations with price controls on petrol, which result
ed in shortages. Since 1981 they have steered clear of such controls,
which has made for more volatile crude prices but smoother mar
ket adjustments. Some tweaks in behaviour have got easier thanks
to the pandemic: if air fares soar, why fly to that business meeting
when you can log on to Zoom instead?
Central bankers may also be less tempted to jack up interest
rates simply because of soaring energy prices, thereby reducing
the risks of a recession. There is a debate over whether the pass
through from oil shocks to core inflation is basically nil, as argued
in a paper for the Fed by Todd Clark and Stephen Terry, or small, as
argued in another Fed paper by Cristina Conflitti and Matteo Lu
ciani. However, the experts agree that the passthrough has weak
ened, in part because of the diminished energy intensity of
growth. Even before the war in Ukraine, the Fed was set to raise in
terest rates several times this year in order to rein in inflation. The
salient point is that, according to market pricing, investors do not
believe that the oil shock will lead to much more aggressive moves
by the Fed than previously expected.Shale fellow well met
A final difference with past oil shocks is the momentous evolution
of America’s status in the global crude industry. In the first decade
of the 2000s America imported more than 10m barrels of oil per
day in net terms. With the shale revolution, American oil produc
tion has soared, such that it now meets most of its energy needs
from its domestic production. In 2020 America became a net ex
porter for the first time since at least 1949.
One effect is that oil shocks are now less destabilising for the
American economy in aggregate. Consumers may dislike rising
crude prices but oil producers enjoy them. A key question in the
months ahead will be the extent to which they expand drilling.
That would help offset the economic loss from softer consumer
spending. And for the rest of the world, a resilient American econ
omy would provide useful ballast amid all the turbulence. The eu
must worry not just about oil but also about a much more acute
shortage of natural gas. Should it join America and Britain in ban
ning Russian imports,the price of crude could go much higher
still. But at oil’s currentprice, the world economy can, with luck,
withstand the shock.nFree exchange
Will soaring crude prices lead to a recession?