Full text of Economic Synopses : A Case for Oil?, 2003, No. 14

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Economic SYNOPSES
short essays and reports on the economic issues of the day
2003 ■ Number 14

A Case for Oil?
Richard G. Anderson and Michelle T. Meisch
s economic growth slowed during the first half of 2003,
the American liberation of Kuwait. In 2003, similarly, prices
many analysts again focused on increases in the price
rose sharply during the military buildup, when uncertainty
of oil. In the United States, increases in the price of
regarding war was high, and then decreased after the degree
oil generally have preceded business-cycle downturns since
of uncertainty was reduced by the American entry into Iraq.
World War II.1 In late February, oil prices were close to $40
During both episodes, oil futures prices (not shown) moved
in similar patterns; indeed, even during 2003, futures prices
as oil supplies were throttled in Venezuela and Nigeria and
generally remained below the spot price, suggesting that the
the world anticipated war in the Middle East. Some analysts
price run-up would be short-lived.
feared prices could reach $50 if the war in Iraq bogged down
The similarity of oil price movements during 1990-91 and
into an urban guerilla conflict or spread to other nearby oil2002-03 suggests that the slow pace of economic activity durproducing nations. At the same time, nuclear power-supply
ing this year’s first-half should not be attributed to higher oil
troubles in Japan and unusually cold weather in the United
prices. It also suggests that the recent retreat of oil prices to
States boosted demand. Fears of further sharp oil price
more normal levels may provide no more than a small boost
increases seemed well-founded.
to economic growth later this year. ■
An extensive economics literature has explored the various mechanisms whereby higher oil prices affect economic
1
See Kevin L. Kliesen, “Rising Oil Prices and Economic Turmoil,” Federal Reserve
activity.2 One of the more plausible mechanisms operates by
Bank of St. Louis Regional Economist, January 2001. www.stls.frb.org/publications/
means of the postponement effect. In this scenario, increases
re/2001/a/pages/lead-article.html.
2
in the current price of oil increase uncertainty about future
Many of these mechanisms are discussed in James D. Hamilton, “What Is an
oil prices which, in turn, causes households and businesses
Oil Shock?” Journal of Econometrics, April 2003, Vol. 113, pp. 363-98.
to postpone purchases of durable goods and equipment.
Unraveling the economy’s recent performance depends, at
least in part, on understanding the extent to which
businesses and consumers believed that this year’s
Weekly Oil Prices
oil price increases would be reversed in the near
future. If this belief was widely held, then oil prices
Price per Barrel ($US)
45
might have affected business and consumer spending
Oct. 12, 1990
very little—and the economy’s slow growth might
40
have been signaling broader underlying weakness.
June 28, 2002
35
It seems plausible that many firms and households
judged world events during 2002-03 by comparing
30
April 26, 1991
them to those that surrounded the first Gulf War.
March 7, 2003
25
Looking back, oil price movements during 2002-03
in fact were quite similar to those during the 1990-91
20
Iraqi invasion of Kuwait and subsequent Gulf War,
15
albeit with somewhat different timing. The figure
Feb. 2, 1990
10
shows the spot price for benchmark Texas-type
1990-91 Conflict
light, sweet crude oil before and after the peak price
5
2002-03 Conflict
observed during each period. (We aligned the prices
0
based on the peak price because of the differing
1
9
17
25
33
41
49
57
65
timing of events.) In 1990, prices peaked after the
Weeks
Kuwait invasion but well before the beginning of

A

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