Standard macroeconomic textbooks usually equate lower oil prices in oil-importing countries with a reduction in costs and an increase in real private consumer spending. So, the sharp decline in the global price of crude oil-and hence, in the price of US gasoline-after June 2014 was initially expected to boost the US economy.
However, this traditional wisdom is at odds with the actual data. From second-quarter 2014 until this year's first quarter, average US real economic growth has increased only slightly to 2.2% from 1.8%.
This puzzle was recently studied by Christiane Baumeister of the University of Notre Dame and Lutz Kilian of the University of Michigan. In a new paper entitled, "Lower oil prices and the US economy: Is this time different?" Baumeister and Kilian conclude that the net stimulus of lower oil prices to cumulative US real gross domestic product growth since June 2014 is only 0.12 of a percentage point, which is effectively zero.
Transmission channels
Baumeister and Kilian show that breaking down the components of real GDP reveals a striking discrepancy between sharply reduced average growth in real nonresidential investment, driven by a dramatic fall in oil-related investment, and substantially higher average growth in real private consumption. The supply (or cost) channel of the transmission of oil-price shocks emphasized in the 1980s and 1990s, however, may be safely neglected.
"Lower fuel costs do not appear to provide much of a stimulus to firms that are oil-intensive in production (such as the transportation sector or plastics producers). The few businesses other than refining that are heavily dependent on oil inputs performed only marginally better than the rest of the economy after June 2014, if at all."
In contrast, businesses sensitive to fluctuations in consumer demand, such as tourism and retail sales, did far better than average. Average annual real consumption growth accelerated from 1.9% during 2012 and mid-2014 to 2.9% between third-quarter 2014 and this year's first quarter. Lower oil prices, through promoting private real consumption, have raised real GDP by about 0.7 of a percentage point since June 2014.
The results suggest that the primary channel of the transmission of unexpected oil-price declines must have been higher demand for domestic goods and services, which is consistent with a large share of the oil used by the US economy being used by final consumers rather than firms.
However, this stimulus effect was largely offset by a simultaneous reduction in oil-related private nonresidential investment, reducing real GDP growth by 0.62 of a percentage point. Since June 2014, oil investment has dropped at a rate of 48%/year. Excluding investment in the US oil business, real investment would have increased at a rate of 4.6%, or three times as fast as the actual data.
Is this time different?
In late 1985, a shift in Saudi policies caused a large and sustained decline in the global price of oil in 1986, resulting in an increase in private consumption and a decline in oil-related nonresidential investment-much like today.
However, the decline in oil-related investment after June 2014 was about twice as large as the decline in 1986. The magnitude of this decline is not surprising, Baumeister and Kilian argue, because the cumulative decline in the price of oil after June 2014 was twice as large as that after December 1985, while the share of oil and gas extraction in GDP was about the same in 2014 as in 1985.
Moreover, the price drop in 1986 was caused by developments in the global oil market alone, whereas in 2014-15, it was also associated with a global economic slowdown, which is reflected in a lower growth in US real exports. Had US real exports continued to grow at the same average rate of 3.2%/year as between first-quarter 2012 and second-quarter 2014, Baumeister and Kilian noted, average US real GDP growth after mid-2014 all else equal would have increased to 2.5%.