Fed: Economic diversification muffles oil price effects in US

Efforts to diversify the US national and regional economies away from dependence on the energy industry have diminished the overall economic effects of oil prices, say economists with the Federal Reserve Bank of Dallas. This has, to a great degree, shielded the US financial system from the effects of a tripling in oil prices over the last 18 months.

Stephen P.A. Brown, director of energy economics and microeconomic policy analysis for the Federal Reserve Bank in Dallas, and Mine K. Yucel, regional and energy economist for the Fed, reported these findings in a recent article in the July-August issue of Southwest Economy.

A "dramatic and persistent increase" in oil prices could still slow the US economy while stimulating the economies of energy-producing states. The decisions of the Organization of Petroleum Exporting Countries still also hold sway over oil prices, said the authors, "given its market share, large reserves, and low production costs."

However, Brown and Yucel noted that oil's influence on the US economy is weakening as the national and regional economies diversify, branching into "the high-tech industry that characterizes the new economy" and away from total dependence on the energy industry.

While oil prices have tripled, the higher prices are moderate by historical standards, say the economists. When adjusted for inflation, crude oil prices today are near the levels seen in the early 1970s, despite climbing to a 10-year high of $34/bbl in early March. The increase also resembles the 1979-81 price hike that led to a severe recession, the economists said.

Oil price-employment correlation
Brown and Yucel said their research shows a strong correlation between oil prices and the unemployment rate in the past. During the 1950s and '60s, small rises in oil prices had a stronger impact on a then more-sensitive economy, usually resulting in recessions. Output and productivity usually slow when oil prices rise, indicating a shortness of energy and "classic supply-side shock."

Rises in oil prices during the 1970s, '80s, and early '90s also resulted in higher unemployment rates in 1982, 1990, and the late 1990s. However, Brown and Yucel said the relationship between oil prices and the number of unemployed has weakened since the mid-1980s, when rising oil prices began not always to lead to recession.

Brown and Yucel pointed out that, in 1997, the oil and natural gas sector accounted for only 8% of Texas' gross state product, compared with about 20% in 1981. Because the energy industry is less prominent in Texas, employment in that state is about 75% less sensitive to oil price movements than it was in 1982. Similar changes in sensitivity for employment are noted for Louisiana, Oklahoma, and New Mexico.

Only eight states are being helped by this year's high oil prices, the economists said. In the past, the economies of Kansas, Montana, Utah, and West Virginia�all energy-producing states�were helped by rising oil prices. Economic activities in these states have been changed so much by diversification, said Brown and Yucel, they are now hurt instead of helped by the upswing in oil prices.

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