Oil price plunge should raise real incomes and boost growth
|
Version 0 of 1. The pattern of the global economy since the second world war is clear. There have been three booms and four busts. The three booms were all associated with low oil prices. The four busts were all associated with rising oil prices. Given that historical pattern, it is a bit curious that financial markets are in such a tizz about the sharp fall in the cost of crude since last summer. Brent crude was back then trading at around $115 a barrel: it is currently struggling to stay above $50. Shouldn’t cheaper energy lead to stronger consumer spending, higher investment, surging corporate profits, and hence rising share prices? The short answer, of course, is yes. Unless the collapse in the oil price has been the result of falling demand, cheaper energy should eventually lead to a pick up in global economic activity, as it did in the 1950s and 1960s, in the mid-1980s and in the 1990s. Consumers will have more spare cash after filling their cars and paying their heating bills; companies will see the costs of running their businesses go down. Six years ago the fall in the oil price from a peak of $147 a barrel to below $40 a barrel was the result of a demand shock. The near-collapse of the global financial system meant credit dried up, and for a while industrial production and trade were contracting at a rate not seen since the Great Depression. What’s happened in the past six months or so is more of a supply shock. Sure, there has been a slight easing in global demand for crude caused by the slowdown in China and the stagnation in the eurozone. But this has been nothing like as dramatic as the collapse in activity during the winter of 2008-09. Instead, falling oil prices are more to do with over-supply from three big sources. The first has been the expansion of shale production in the US, the big structural change to the market since the financial crisis. The second has been the decision by Saudi Arabia to flood the market with cheap crude, thus forestalling any attempts by Opec to put a floor under the price by limiting output. The third has been increased production from countries – such as Russia – which are trying to protect their oil revenues as prices fall. Consumers are already feeling the benefits of this positive supply shock through cheaper petrol and rising real incomes. This will eventually feed through into stronger growth, which in turn will put a floor under the oil price. Crude may edge lower over the coming weeks, but it is unlikely to go much lower. |