When the world's oil producers last week agreed to cut production, TV news shows flashed harrowing images of gasoline stations across the nation's screens, warning of a potential rise in energy prices.
Oil prices rose more than $5 a barrel from their December lows in advance of, and following,
agreement to cut production. At its March meeting, OPEC agreed to cut output by 1.7 million barrels a day.
Higher prices at the pump will cut into the cash consumers have to spend on other goods and services. The rise in oil prices, more than a steep drop in equities or a global shock, is likely to cause the moderation in the economy that economists have expected for the last two years. But economists say rising energy prices tend to cause temporary jitters more than a profound and prolonged change in spending habits.
"We really would have to see big increases by energy product prices to damage consumer spending" perceptibly, says John Lonski, senior economist at
. "We're starting off from low prices. We probably would have to have crude jump to $20 a barrel."
How Important Is Oil?
Rising energy prices are well reflected in the overall
Consumer Price Index
basket of goods that determines the rate at which prices are rising. At last reading the CPI was rising 1.6% on a year-over-year basis. The core CPI, which eliminates volatile food and energy prices, was up 2.1% on a year-over-year basis.
Energy makes up 6.3% of the overall CPI. The price of a gallon of gas rose to $1.09 March 22 from 94 cents two weeks previous, according to the
of 10,000 gas stations nationwide.
According to Ken Mayland, chief economist at
in Cleveland, the volume of oil imports in 1998 grew 8%, or 4.1 billion barrels, from a year earlier. But falling prices cut the total oil import bill by more than $22 billion. Lately the price of crude oil was around $16.80 a barrel, up from its trough last year below $11 a barrel.
Consumers' spending patterns, over a longer period, tend to vary based on future economic and employment expectations, not necessarily according to prices in one sector of the economy. But the rise in prices, even if it only affects spending habits for a couple of months, might be enough of a factor to put the
back firmly on neutral ground.
"What we've found historically is that
energy prices tend to be important for the consumer," says Mike Niemira, economist at
Bank of Tokyo-Mitsubishi
. "I suspect it will have more of a near-term effect. Ultimately, it will slow consumption and growth and get the Fed back into the picture of less growth."
It's important to note, however, that crude oil futures only today even matched March 1998's highest level, about $16.75 a barrel. At that time, the overall CPI was rising at a 1.4% pace, rising to 1.7% two months later.
The specter of rising oil prices becomes more serious if prices of other raw materials rise sharply in tandem, based on increased demand coming out of a recovering Asia. This hasn't happened yet -- the
Commodity Research Bureau's
index lately was just above 192, not far off its all-time low.
"The same forces, such as Asia rebounding, that are affecting oil will affect other raw material prices as well," says Mayland. "My thinking there is commodity prices have bottomed, and they too will gradually edge higher."
Were this to happen, it would force changes in activity among producers that purchase those materials to make those goods. If they were forced to raise their prices, that could be passed on to the consumer.
The rise in prices may have other mild effects on the U.S. economy, some of which may help maintain the balance between inflation and strong growth that currently exists. It might be enough to cause a bond rally, however short-lived. This, in turn, could spur more spending in the housing sector for those enticed by the lower mortgage rates that result. As a result, spending would then strengthen on the backs of more interest-rate savings incurred. "It may have a perverse effect in that sense," says Niemira.
All this assumes the cuts will materialize, period. There's always a chance that oil producers that agree to the cut will then cheat and produce more to take advantage of the price increase. This would end up cutting into some of the price increase to begin with. OPEC cut production last year but has only adhered to 77% of that cut.
Oil prices might have hit a ceiling, at least for the near term. And as with other factors that affect consumer spending on a short-term basis, ever-fickle consumers tend to discount this if employment prospects remain good and the prospects for income growth are strong.
"It's enough probably to push down consumption in the second quarter, and the third quarter possibly," says Niemira. "In a sense, it's an external shock to the economy."