Not Again: The Summer Vacation Gas Price Roller Coaster on the Move Again — Why Energy Price Volatility Hurts Families, Businesses, and the Economy

Center for American Progress / by Christian E. Weller and Jaryn Fields
http://www.americanprogress.org/issues/2011/05/pdf/gas_price_volatility.pdf

…The upswing in gas prices this spring is reminiscent of several springs in the past. Prices at the pump also soared by more than 30 percent in the spring of 2002, the first year of such large price increases in the spring, and then again in 2004, 2006, 2007, 2008, and 2009—not even taking a break for the Great Recession.  And then, in almost all cases, prices fell  precipitously, occasionally even to their earlier levels, once the summer was over…These large price swings for gasoline and other energy prices make it even more difficult for families, businesses, and ultimately the economy to plan for the future.

…the combination of high prices followed by increasing volatility quickly obscures these basic responses to higher prices. This confusing energy price dynamic makes it difficult for families to budget expenses, estimate commuting costs, and make the informed economic decisions that will impact their households since families cannot really see where prices are heading amid the massive volatility. Many families consequently wait to buy a more fuel efficient car, or move closer to public transit, among other things, until they get a better sense of where prices are really headed. Businesses will similarly delay energy saving investments in more fuel efficient car and truck fleets, as will state-and-local governments and the federal government. And both consumers and businesses hold off on other energy-saving investments such as energy efficiency repairs or upgrades to homes, office buildings, and factories.

And now the cycle begins anew. What’s more, families, businesses, and governments could be once again caught off-guard by rapidly rising prices at the pump next vacation season after watching prices fall in the autumn and winter, leaving
our economy still heavily dependent on petroleum. In this paper we summarize past data on gasoline and energy price volatility, and consumer and business spending, and then make recommendations on how to avoid this very predictable
and debilitating cycle in the future. We find that:

• Consumers will delay purchasing a car after experiencing a period of high gasoline price volatility. Families’ investment in residential structures, which includes new home purchases and upgrades to homes, is on average 0.5 percent of gross domestic product lower than is typical, following high volatility, or about $75 billion in the current economy.

Families spend less on home improvements and home purchases following a period of high energy price volatility. There is a 78.9 percent chance that business investment in transportation equipment as a share of GDP will decline after high energy price volatility. Businesses will buy 7.5 percent fewer vehicles than is typical, putting off purchases due to unstable and unpredictable prices.

Businesses also reduce their investment spending after periods of high energy price volatility. The so-called profit rate (profits to assets) of the oil industry is significantly higher during times of high energy price volatility, likely because the price spikes underlying increased volatility result in higher retail prices and more consumer spending, without an equal offsetting effect when prices go down again.

The oil industry, in comparison, profits from periods of high volatility. The so-called profit rate (profits to assets) of the oil industry is significantly higher during times of high energy price volatility, likely because the price spikes underlying increased volatility result in higher retail prices and more consumer spending, without an equal offsetting effect when prices go down again.

H/T: Michael Levi’s blog where he has his own take:

The study isn’t perfect. In particular, while the authors do seek out measures that won’t be confounded by price trends, they don’t take the obvious step of doing a statistical analysis that controls for prices trends explicitly. Nor is it comprehensive: among other things, volatility can mess with the economy through inflation, which can provoke problematic responses from monetary policymakers.

That said, the CAP study is useful, both in emphasizing that volatility is in and of itself a problem, and in putting some numbers on it. Expect more on the subject here soon.

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