If oil prices rise steadily, will economical growth eventually resume despite of it?

Question

I am trying to find out whether decline in growth is actually mechanically linked to oil price rises, or whether oil price rises merely represent a psychological shock factor whose detrimental effect wears off once consumers get used to the new reality, resulting in resumed growth. The bottom line of what I'm trying to understand is whether an oil-based economy is inevitably in decline when oil is in decline, or whether an oil-based economy is only in decline (even though oil may also be in decline) as long as anyone is frightened by this for lack of alternative scenarios.

Answer 1

Things can price themselves out of the market. I think people refuse to let oil prices effect what they want to do, at least for now, mostly due to arrogance and pride. When people stop buying, prices fall. This is the only way the consumer controls the market. The oil companies know this and they'll push prices to the limit until they see a decline in spending. This is capitalism at work and smart business. No one ever went broke under-estimating the intelligence of the American public.

Answer 2

I like NC's approach, but it assumes the relationship between oil and GDP is constant. The reality is that if we have a regime change (stats term, not poli sci) the historical relationship doesn't hold.

Also, with regards to your question, oil price has risen steadily since 2001 and worldwide GDP growth has been strong as well. I would say that the oil price growth is largely a response to increased oil demand given the factors causing worldwide GDP growth (GDP does require energy, though some economies use energy more efficiently than others).

When you talk about an oil-based economy, it depends if you are talking about an economy that is a heavy consumer of hydrocarbons (US) or one that is a heavy producer (Saudi Arabia). Clearly a decline in oil prices benefits the consumer while hurting the producer.

The relationship between growth and energy is strong. Whether or not the energy has to come from oil is debatable. There is also a lot of room to increase efficiency, which would result in a lower ratio of $GDP/bbl of oil.

Answer 3

There are two things to consider when looking at this question.

1) Economics and the laws of supply and demand
2) Econommics and the effect of substitutes.

1) By definition, it is impossible for both the economy to decline indefinitely while oil is declining. As prices increase demand is decreased. While the amount it decreases will vary depending on the price and the price change, eventually a point will be reached where supply exceeds demand. At this point economic growth would resume, even though the overall supple of oil in theworld is decreasing. The overall supply in the world is not necessarily the same as the amount supplied.

2) Adding substitutes to the equation changes it even more. As the price of oil increases, substitutes that were previously too expensive suddenyl become cheaper, substitutes such as electric engines, hydrogen engines, and nuclear power (powerplants). This causes a decrease in demand, which will lead to a decrease in price. So, oil becomes cheaper and the economy grows and/or ol is no longer used and the economy grows.

So, yes, either way growth will eventually resume because it is impossible for the price to continuosly go up indefinitely at a rate that will cause economic decline.

Especially with the number of substitutes for the automobile, which is the largest user of oil.

Answer 4

This is pretty easy to figure out. Get time series for oil prices and real GDP and estimate three regression models:

(1) GDPG = a + b * OIL
(2) GDPG = a + b * OILG
(3) GDPG = a + b1 * OIL + b2 * OILG

where GDPG is real GDP growth,
OIL is the price of oil, and
OILG is the increase in the oil price compared to last year.

Then compare the R-squared and the t-statistics for the three models. If the first model is best, it is an argument in favor of the "mechanical linkage" hypothesis. If the second model is best, it is an argument in favor of the "shock factor" hypothesis. If the third model is best, it is an argument in favor of the interplay of the "mechanical linkage" and "shock factor".