Wednesday, October 21, 2009
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.
Posted by Scott Grannis at 6:23 PM