Petroleum products - Prices ; Petroleum industry and trade

Michelle T. Meisch

Richard G. Anderson

English

Research Papers in Economics

June 2003
NationalEconomicTrends
Views expressed do not necessarily reflect official positions of the Federal Reserve System.
A Case for Oil?
A
s economic growth slowed during the first half of
2003, many analysts again focused on increases
in the price of oil. In the United States, increases
in the price of oil generally have preceded business-cycle
downturns since World War II.1 In late February, oil
prices were close to $40 as oil supplies were throttled in
Venezuela and Nigeria and the world anticipated war in
the Middle East. Some analysts feared prices could reach
$50 if the war in Iraq bogged down into an urban guerilla
conflict or spread to other nearby oil-producing nations.
At the same time, nuclear power-supply troubles in Japan
and unusually cold weather in the United States boosted
demand. Fears of further sharp oil price increases seemed
well-founded.
An extensive economics literature has explored the
various mechanisms whereby higher oil prices affect
economic activity.2 One of the more plausible mecha-
nisms operates by means of the postponement effect. In
this scenario, increases in the current price of oil increase
uncertainty about future oil prices which, in turn, causes
households and businesses to postpone purchases of
durable goods and equipment. Unraveling the
economy’s recent performance depends, at
least in part, on understanding the extent to
which businesses and consumers believed
that this year’s oil price increases would be
reversed in the near future. If this belief was
widely held, then oil prices might have affected
business and consumer spending very little—
and the economy’s slow growth might have
been signaling broader underlying weakness.
It seems plausible that many firms and
households judged world events during
2002-03 by comparing them to those that
surrounded the first Gulf War. Looking back,
oil price movements during 2002-03 in fact
were quite similar to those during the 1990-91
Iraqi invasion of Kuwait and subsequent Gulf
War, albeit with somewhat different timing.
The figure shows the spot price for benchmark
Texas-type light, sweet crude oil before and
after the peak price observed during each period. (We
aligned the prices based on the peak price because of the
differing timing of events.) In 1990, prices peaked after
the Kuwait invasion but well before the beginning of the
American liberation of Kuwait. In 2003, similarly, prices
rose sharply during the military buildup, when uncertain-
ty regarding war was high, and then decreased after the
degree of uncertainty was reduced by the American entry
into Iraq. During both episodes, oil futures prices (not
shown) moved in similar patterns; indeed, even during
2003, futures prices generally remained below the spot
price, suggesting that the price run-up would be short-lived. 
The similarity of oil price movements during 1990-91
and 2002-03 suggests that the slow pace of economic
activity during this year’s first-half should not be attributed
to higher oil prices. It also suggests that the recent retreat
of oil prices to more normal levels may provide no more
than a small boost to economic growth later this year.
—Richard G. Anderson and Michelle T. Meisch
1See Kevin L. Kliesen, “Rising Oil Prices and Economic Turmoil,” Federal
Reserve Bank of St. Louis Regional Economist, January 2001.
<http://www.stls.frb.org/publications/re/2001/a/pages/lead-article.html.>
2Many of these mechanisms are discussed in James D. Hamilton, “What Is an
Oil Shock?” Journal of Econometrics, April 2003, Vol. 113, pp. 363-98.
Available on the web at research.stlouisfed.org
Weekly Oil Prices
0
5
10
15
20
25
30
35
40
45
1 9 17 25 33 41 49 57 65
1990-91 Conflict
2002-03 Conflict
Feb. 2, 1990
June 28, 2002
Oct. 12, 1990
March 7, 2003
April 26, 1991
Price per Barrel ($US)
Weeks

A case for oil?

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A case for oil?

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