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Energy Voices: Insights on the future of fuel and power

Gas prices: Can the economy weather another rise to $4 gas?

High oil prices and rising gas prices weaken an economy because they reduce discretionary spending and indirectly cause people to be laid-off from work, Tverberg writes. Can the US economy stand another jump in prices?

By Gail TverbergGuest Blogger / October 5, 2012

Motorist Tony Klein fills up his 1967 Cutlass V-8 at a gas station in Los Angeles Thursday. Tverberg argues that rising gas prices will not threaten the American economy or President Obama's chance for re-election.

Damian Dovarganes/AP/File

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Prof. James Hamilton of University of California recently wrote a post called Thresholds in the economic effects of oil prices. In it, he concludes

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Gail Tverberg, an actuary with a background in math, analyzes energy and financial matters from a perspective that the world has limited resources. For more of Gail's posts, click here.

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As U.S. retail gasoline prices once again near $4.00 a gallon, does this pose a threat to the economy and President Obama’s prospects for re-election? My answer is no.

EDIT - I originally wrote this post thinking that Prof. Hamilton was looking at a broader question: Can an economy learn to live with increasingly high oil prices? After looking again at his article again, I realize that he is talking about a narrow question: Using the figures he was looking at (average gasoline prices across all grades), prices were then near $4 a gallon, as they had been several times in the past, as they bounced up and down.

In that context, what he says is far closer to right than what my analysis of the broader question of whether an economy can learn to live with increasingly high oil prices, below, would suggest. There is a difference, because gasoline prices are not too closely tied to oil prices in short term fluctuations, and because the issue is likely to be as much one of consumer sentiment as anything else, as long as the issue is simply one of gasoline prices in a not-too-wide range. But I think there are some longer-term, more general issues we should be concerned about. 

My Analysis of the More General Question: Can an Economy Learn to Live with Increasingly High Oil Prices?

As I see it, increasingly high oil prices weaken an economy because they reduce discretionary spending and indirectly cause people to be laid-off from work. They have many other adverse effects as well–they tend to raise food prices, with similar effect. The laid-off workers require unemployment compensation payments, and the same time they are contributing less tax revenue. All of this creates a huge imbalance between revenue collected by governments and expenditures paid out. If oil prices rise again, it will tend to make the imbalance worse.

An economy such as the United States can cover up the problems caused by high oil prices with variety of financial techniques. In my view, high consumer confidence measures the success of those cover-ups, more than it measures the actual underlying situation. One way the US government has managed to cover up how badly the economy is being hurt by high oil prices is by spending far more than the government takes in as revenue. This has happened continuously since late 2008, with outgo exceeding income by more than 50% each year, even though the country is supposedly not in recession.

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