Causes and Consequences of the Oil Shock of 2004
James D. Hamilton
All but one of the recessions since World War II have been preceded by a dramatic increase in crude petroleum prices. Recent turbulence in energy markets has some analysts speculating that, in the immortal words of Yogi Berra, it could be déjà vu all over again. However, it is my opinion that, if prices increase no further than they already have, the oil price spike of 2004 will slow GDP growth by about one percent, but is not enough to derail the ongoing robust economic recovery.
The current behavior of oil prices is unlike the spike that preceded earlier recessions in two
key respects. First, oil prices have
gone up to a large degree not because of a shortfall of supply but rather
because of an increase in demand. The
world is producing 3 million more barrels of oil each day relative to last
year, nearly a 4% increase. But demand
is up even more dramatically.
This is quite a different situation from other historical oil shocks that were caused by military conflicts that physically disrupted the production or delivery of petroleum, forcing consumers and firms to make less use of this vital input. The current situation, to a large extent, is simply that we have to share the increased supply with other consuming nations. There should be no quarrel with the proposition that a booming world economy overall is good economic news, not bad.
To be sure, concerns about supply have also made a contribution to the recent run-up in prices. Iraqi production is not as strong as was expected at this point, and even maintaining current levels could prove problematic. The market is sufficiently tight that any new supply concerns, such as the ongoing negotiations over Russian production, quickly show up in higher prices. Production worldwide has dropped slightly over the last few months, and this would certainly be a source of much concern if that trend continues.
The second way that the current oil price spike differs from
those that preceded earlier
There are some other dimensions of the current situation that
aggravate the problem and warrant policy changes in the
A second on-going concern is the possibility that military or
civil conflict could disrupt petroleum production or shipments from
However, the oil futures markets are not betting very heavily on such pessimistic scenarios—the current price of oil futures contracts shows a steady decline for the next year and beyond. Assuming that the market is right on this one, we will see a slowdown of U.S. GDP growth rates, but no recession in 2005.