Are Oil Price Declines Good for the Economy?

Abstract

S ince mid-June, the spot price of the U.S. benchmark for crude oil, West Texas Intermediate (WTI), has fallen from a bit less than $108 per barrel to a bit less than $50 per barrel—a decline of more than 50 percent. Much of the economic research on the effects of crude oil prices on the macroeconomy has focused on the effects of rising oil prices: Sharp increases generally have a negative effect. In fact, oil price increases have preceded 10 of the past 11 U.S. recessions.1 But do falling oil prices, overall, have positive effects on the macroeconomy? Here the research is less conclusive: Some researchers argue they don’t and some argue they do.2 In general, though, as with rising oil prices, the effects depend on the source of the shock affecting the supply or demand. Falling oil prices have numerous effects—some positive and some negative. On the positive side, lower oil prices tend to lower overall inflation and, to some extent, mea sures of inflation expectations. All else equal, lower inflation and inflation expectations tend to lower nominal interest rates and may spur increased demand for interestsensitive durable goods such as automobiles and housing. Lower oil prices also help to reduce operating expenses of the transportation sector and other industries that are relatively large users of gasoline, diesel, and jet fuel. There is also evidence that lower oil price volatility is associated with increased capital expenditures by businesses. On the negative side, lower oil prices reduce the extraction and drilling incentive for producers, which has become more important in recent years since the United States has become a large crude oil producer. Reduced drilling activity has an immediate effect on industrial production and, ultimately, on nonresidential fixed investment.3 Although drilling activity remained high for a few months after oil prices peaked and began to decline, the number of rotary rigs drilling for crude oil in the United States has declined by about 23.3 percent since mid-October 2014.4 The table provides a gauge of the economic effects of falling crude oil prices, showing the average peak-to-trough change in oil prices and various measures of economic activity for five non-recession episodes since 1983. The five episodes and their respective peak-to-trough decline in oil prices (in parentheses) are November 1985–July 1986 Are Oil Price Declines Good for the Economy?