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At the request of my friend Doug R, which in turn was a reaction to my post earlier today, here's a chart showing real crude oil prices and recessions. He thought recessions were basically a direct result of a spike in oil prices, but wanted to see the evidence. Here it is.
My reading of this chart is this: recessions are often, but not always, associated with a spike in real oil prices. I think there is something else going on behind the scenes that is more important than oil prices, and that something is monetary policy.
Every recession on this chart was preceded to a significant degree by a tightening of monetary policy, and this observation taught me long ago that it is monetary policy that creates recessions. With one exception, every recession in the postwar period has been preceded first by easy money and then by a significant rise in inflation and a subsequent tightening of monetary policy. When inflation rises, it typically boosts the prices of raw materials, oil included. So the rise in real oil prices precedes some recessions is really just a symptom of rising inflation, which in turn is the result of easy monetary policy.
You can see this clearly in the next chart. Tight monetary policy invariably produces high real short-term interest rates (the blue line) and a very flat or inverted yield curve (shown here as a low or negative value of the red line). Easy money, on the other hand, pushes real borrowing costs to very low levels and results in a very steep curve (shown here as a high value of the red line).
The one interesting "exception" to my recessions-are-caused-by-tight-money rule was the recession of 2001, since it was preceded by tight money but not by rising inflation or exceptionally high oil prices. The Fed tightened policy in the late 1990s not because inflation was rising, but because they were afraid it might; this was a very unusual period in which the Fed was uncharacteristically preemptive in its policy actions. Sadly, although the tightening was probably not required, it still produced some painful consequences. The key factor triggering recessions remains, however: tight money. I would note also that while the 1990-91 recession saw a big but brief spike in oil prices, this was mainly due to the outbreak of the gulf war.
Since I don't think oil prices have yet risen by enough to result in any meaningful change in consumer behavior, and inflation hasn't yet risen by enough to trigger a big tightening in monetary policy, and the Fed is still very easy, I don't see any reason to fear a recession or double-dip recession.
9 comments:
Agree with your point regarding the Milton Friedman/Monetary perspective. Inflation is demand pull and only short term cost-push.
However, Energy Prices clearly change consumption functions and production functions. Friedman recognized this phenomena as the shorter term effect (cost push).
Cost-push effects, in the short run, given hyper-debt levels, real unemployment of 16%, and the world’s goofiest stimulus plan, need taken into consideration.
Scott, you're a Prince. Thanks for the chart showing the correlation between oil prices and recessions. As you have taught me correlation doesn't mean causation, but it is pretty tempting to interpret such representations in that way.
One thing to keep in mind, seems to me, is the unique nature of oil as a commodity. I am wondering if you can discern a trend amongst your data which might reveal a correlation between the behavior of the American economy before and after the peaking of domestic petroleum production in the first half of the 1970s. Before this point we had ever increasing production and we were a major petroleum exporter. After that, until the development of Alaskan oil, and now as Alaskan oil declines, we became increasingly an importer of petroleum. Is there a pattern there in the economy? How about in countries depending on income from the production in the North Sea, which is now in decline?
I understand that there are other variables in play, but (as you know, Scott) I keep coming back to oil's pivotal nature and the fact that all our thinking about oil and the economy generally has taken place in a time of increasing production, a time which is now in the past.
How will this effect our thinking, and how will this effect our reality?
CPI went from 1.4% y/y in Mar-98 to 3.8% y/y in Mar-00. PCE deflator shows a similar dynamic. Clearly this is "rising" inflation; one could quibble whether it is "high" or not. But I'm curious as to why you wrote that "[the] recession of 2001...was preceded by tight money but not by rising inflation...". Is this simply because inflation had begun to decline before the official start of the recession?
MW: The yoy change in CPI fluctuated with oil prices, but the trend from 1992 through 2003 was actually one of a modest decline.
Doug: I don't think the decline in U.S. oil production had much to do with any changes in the economy. But I do think there were some political factors which might explain it, such as the ban on offshore drilling, and the ban on ANWR exploration.
The U.S. has gobs of oil (in the form of oil shale) that is not being exploited, and potentially lots of oil that is politically off limits (offshore and ANWR).
What your charts tell me is that we are headed for another Fed induced bubble bursting almost guaranteed.
It is a question of when, not if.
Skyrocketing asset prices fueled by cheap capital are not a problem until they are, and we are already on a path towards making this happen.
The combination of high unemployment and slack in production make it politically difficult for the Fed to do anything but keep the pedal to the medal.
Besides, this is how they conduct monetary policy anyway. Asset prices are not really in their doctrine. The Fed runs an ex-post operation.
React and clean-up instead of lean against counter cyclical behavior. Another busted is seriously almost assured.
For anyone interested here is a link to a web publication called Oilwatch Monthly: "The Oilwatch Monthly is a newsletter that is available free of charge with the latest data on oil supply, demand, oil stocks, spare capacity and exports."
The link will take you to an article on The Oil Drum where you can download the latest Oilwatch:
http://europe.theoildrum.com/node/5896
Public: we may indeed be headed to another Fed induced bubble. But until that time, I think it pays to be bullish. Bubbles don't happen in a matter of months, they take years. I don't see many egregiously overpriced assets right now. Gold is expensive, but not terribly so. Treasuries are expensive, but they were outrageously expensive at the end of last year. Real estate is just beginning to bottom, and has a very long way to go before reaching another bubble. Commodities are only about half of the way back to the bubble levels of early 2008.
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