Four Reasons Rising Oil Prices Won't Derail the Economic Recovery

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gasoline pump pricesAnalysts raised their oil-price forecasts this week to a consensus of $86 per barrel by 2011, according to a Reuters poll. That's an increase of $3 per barrel from the November forecast. But if the analysts are right, oil at $86 per barrel will likely have a trivial economic impact: After all, the crude-oil price closed above $89 per barrel Monday.

On Monday evening, I appeared by phone (thanks to a sudden snowstorm) on CNBC's The Kudlow Report to debate whether rising oil prices will derail the economic recovery. Here are four reasons I think they won't:

  • We're using energy more efficiently, and we've diversified the economy. The oil price spikes in the 1970s and 1980s had a big negative effect on the U.S. economy. But back then, according to the Energy Information Administration, energy represented 14% of gross domestic product. That figure is now a much lower 7%. That means the country produces more using less energy -- and the rising cost of energy has less of an overall impact. And that's why the U.S. GDP continues to rise -- even as oil prices rose -- in the 2000s.
  • The recent increase in energy prices hasn't slowed economic growth. Gasoline prices have grown 11% in the last few months, with no perceptible slowing in economic growth. The most recent quarter showed GDP increasing at a 2.5% rate.
  • When oil prices hit $147 in 2007, the economy kept expanding. Before the recession, the U.S. economy continued to grow even when oil prices were much higher. During the times when oil prices breached $90 a barrel in 2007 and 2008, the GDP was growing more than 2.5%.
  • Oil prices are more likely to fall than rise. According to BloombergBusinessweek, oil prices and the dollar are almost perfectly negatively correlated -- that is, when the dollar's value goes up, oil prices go down. With the expectation that the dollar will strengthen in 2011 and 2012, due to accelerating U.S. economic growth and progress toward balancing the budget after the 2012 election, oil prices likely will fall.
While predicting the future is a task rife with pitfalls, my bet is that oil prices won't slow the economy. Of course, if oil hit $250 a barrel, I would probably change my mind. But at some point, rising prices would crimp demand, again causing prices to fall.

Moreover, the recession that began in December 2007 was caused by the collapse of financial institutions, not higher energy prices. If -- as we've done with energy -- we could get Wall Street to become more efficient and lessen its impact on the economy, we'd really be making progress where it counts.
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