The drop in oil prices over the past two years hasn’t helped the economy to the extent that many analysts forecasted. For one thing, the energy industry has fallen hard. Nonetheless, “the negativity from the decline in energy investment should go away over time,” insists Donald Kohn, an economist and a senior fellow at the Brookings Institution in Washington.
The energy price slump, as economists expected, had a positive effect on consumer spending and should lead to a boost in both business and consumer spending.
Oil prices have plunged 58 percent since June 2014, to $45 a barrel. To be sure, they have recouped a small portion of their losses since touching a low of $26 in February — especially this week, after massive wildfires in and around the Canadian oil-producing town of Fort McMurray, Alberta. Overall, though, the downward trajectory prevails — and has caused great pain throughout the energy industry, leading to a 1.7 percent decline in U.S. business investment on average during each of the past three quarters.
One problem is that the oil and gas fracking boom that preceded the oil price slide required a great deal of capital investment, more so than conventional production techniques, notes Joseph Gagnon, senior fellow at the Peterson Institute for International Economics in Washington. As the fracking industry has contracted in response to sagging oil prices, so too has its investment spending. “The upshot of fracking is that when the oil price falls, it shows up as a collapse in spending,” Gagnon says. And the oil price plummet has been larger and more rapid this time around than in the past, exacerbating that effect. The peak-to-trough decline of 76 percent for the 20 months from June 2014 to February 2016 compares with a 46 percent decline for the 20 months from January 1997 to September 1998.
Moreover, the energy industry’s woes have spread into other sectors, just as the housing sector’s troubles did in 2008, says Jeffrey Frankel, professor of capital formation and growth at the John F. Kennedy School of Government at Harvard University. Already, banks have taken a hit on energy loans.
Another reason low oil prices haven’t boosted the economy more is that global economic weakness was a primary reason for the price drop in the first place, Frankel says. Although the U.S. economy is stronger than most of those overseas, with growth of 2.4 percent last year, it has lagged typical recoveries. And the slowdown overseas is hurting the U.S. economy, with the trade deficit acting as a major drag on gross domestic product in the past three quarters.
On the consumer side, the picture is mixed. For every penny that gasoline prices fall, consumers save $1.4 billion a year, says Mark Perry, a professor of economics at the University of Michigan–Flint and visiting scholar at the American Enterprise Institute in Washington. That translates to $75 billion in savings for 2015. There is evidence that some of the savings are being spent.
An analysis from the JPMorgan Chase Institute, using data from Chase’s 57 million debit and credit card customers, shows that consumers spent about 80 percent of their gasoline savings on other purchases from December 2014 to February 2015. Given that consumer spending isn’t soaring and that the savings rate is rising, however, it appears that some of the energy bounty is going toward savings rather than spending.
Consumer spending registered annualized gains of less than 2.5 percent in three of the past five quarters. Meanwhile, the savings rate rose to 5.4 percent in March from 4.8 percent in June 2014.
With interest rates having stayed so low for so long, producing low yields on fixed-income investments, households may be worried that they have to save more for retirement and their children’s college education, Kohn says.
In addition, he and others point out that consumers have sought to reduce their amount of debt since the 2008–’09 financial crisis. “American savings habits have received an adjustment, with people more aware of the need for a cushion,” Harvard’s Frankel says. “In some ways that’s good. But in some ways it means a slow recovery.” In any case, if there had not been even modest increased spending as a result of low energy prices, economists agree that the already slow expansion would have been more sluggish.
In the near future low oil prices will probably do more to help the economy. The investment drop from the fracking industry is likely over now, Gagnon says. And the decrease in oil prices lowers costs for companies that are consumers of energy, freeing up money for them to increase investment.
Of course, oil prices have rebounded a bit over the past ten weeks. We may have entered an oil price range of $40 to $60 for the next five years, Perry says. That would mean gasoline prices would stay close to current levels, continuing to help consumers. And it could enable fracking companies to continue or resume production, boosting the energy sector. A climb into the top half of that range “might be good for the economy on net, because it is just enough to get fracking going without hurting the consumer,” Gagnon says.
Get more on macro.
