Tuesday, April 12, 2011

Energy Prices and Recessions

While the latest Fed Minutes were very encouraging, there were concerns raised about commodity prices:
Overall consumer prices in the United States rose somewhat faster in December and January than in earlier months, as consumer energy prices posted further sizable increases and consumer food prices responded to the recent upturn in farm commodity prices. The price index for PCE excluding food and energy (the core PCE price index) rose slightly in January, boosted by an uptick in prices of core goods after four months of declines; the 12-month change in this core price index stayed near the very low levels seen in late 2010. Recent surveys showed further hefty increases in retail gasoline prices in February and early March, and prices of nonfuel industrial commodities also rose sharply on net. According to the Thomson Reuters/University of Michigan Surveys of Consumers, households' near-term inflation expectations increased substantially in early March, likely because of the run-up in gasoline prices; longer-term inflation expectations moved up somewhat in the early March survey but were still within the range that prevailed over the preceding few years.
The ISM non-manufacturing echoed the problems associated with high fuel costs. The latest report had the following bullet points:
  • "Business is steady. Very concerned about high fuel costs and the speed of any Japanese recovery." (Agriculture, Forestry, Fishing & Hunting)
  • "Housing market still slow getting started. Freight costs going higher. Prices moving up." (Wholesale Trade)
  • "Business activities remain about the same, but the increase in fuel costs has made both a direct and indirect impact." (Public Administration)
  • "Occupancy continues to increase compared to last year by about 3 percent." (Accommodation & Food Services)
  • "The catastrophe in Japan is severely affecting supply chains for magnetic media." (Management of Companies & Support Services)
  • "General state of business has improved slightly over the prior month. There seems to be an increase in qualified customers." (Construction)
The same report showed widespread price increases impacting many groups.

As such, this is a good time to look at the impact of energy prices on the economy. Consider this chart of the year over year percentage change in the energy component of CPI:

(Click for a larger image)

This chart shows some very interesting characteristics. First, note how prices have become more and more volatile. In the 1960s energy prices were constant. In the 1970s we experienced two oil price shocks that led to recessions. Also note that the YOY number started to print higher numbers. Prices settled down at the beginning of the 1980s, but then became more volatile as the 1990s approached. Note the big run up in prices at the end of the 1990s and the heightened volatility that occurred in the 2000s.

Energy prices spiked in relative terms before six of the last recessions -- a point that has been researched in-depth by Professor Hamilton over at EconBrowser. Perhaps most importantly, notice the current YOY percentage change -- while high -- is lower than other recent times when a recession followed. Prior to the early 2000s recession and the latest recession, oil prices hit a YOY percentage change of 20% while currently the YOY percentage change is only at 10%.

For more of Professor Hamilton's work see this article and this PDF link.