The Fundamentals of Oil Shocks

Speculators take most of the heat for the recent oil spike, but were they really to blame for last year’s high prices? Probably not, says Dr. James Hamilton, who argues that supply and demand, not speculators, were behind oil’s 2008 rise.

…Crigger: You’ve written quite a bit about oil shocks, particularly the one in 2008. How did the 2008 oil price spike drive us toward the current recession?
Hamilton: According to the National Bureau of Economic Research, the recession actually started back in December 2007, even though the really dramatic financial developments—like the failure of Lehman—came in September of 2008. So we were in a recession for three-quarters of a year before the really serious financial problems ever started. And if you look just at GDP growth, U.S. GDP was actually growing in real terms over those first three quarters. That’s unusual, to look at a period where GDP was growing and call it a recession. If we hadn’t had the severe downturn in the fourth quarter of ‘08, the NBER might never have said we were in a recession at all.

So given all that, the question becomes: What were the sectors that really were in trouble? One of the very important ones was the U.S. automobile sector, which was subtracting about 0.5 percent GDP growth at an annual rate for those first nine months. There’s no question that, for that sector at least, what was going on with oil prices was very important. Sales of U.S.-manufactured SUVs plunged at the same time that sales of imported, more fuel efficient cars were going up. That combination was unquestionably influenced to a great degree by what was happening in oil prices, and U.S. manufacturers were hit particularly hard.

Also, it was really starting to pinch consumers’ incomes and their spending power as we got into ‘08, which was one factor causing a slowdown in consumption spending. In my opinion, these developments were really what tipped the scale. And if you say the recession started in December ‘07, I think it’s hard to conclude that what happened to oil prices was irrelevant in making that judgment.

Seeking Alpha