James’ previous post on this looked at the falling gasoline prices and argued that it is a good thing for President Bush as the midterm elections approach. I even pointed out that this news, coupled with additional news about the economy slowing down could mean good news in terms of the Fed and rising interest rates.
Now James Hamilton has posted on the declining gasoline prices and notes something very interesting.
What will this mean for the economy? The economic damage of recent high oil prices so far has been milder than I had anticipated, leaving me to be cautious about predicting too big an economic boost from these anticipated price drops. I have long maintained that to the extent that booming demand was the primary factor bidding oil prices up, that reflects positive, not negative, economic fundamentals. But the reverse dynamics appear to be in play at the moment– the incipient economic slowdown is likely a factor in the recent weakness in oil prices, and that, in itself, is bad news, not good.
This might seem somewhat counter intuitive to some. The basic idea here is as follows,
- If gasoline prices are rising due to increased demand due to improved economic conditions, then this is actually a good thing in that it means an improved economy.
- If the above is true, then a decline in oil prices implies a decline in economic activity–i.e. the economy is not improving and may even be declining.
So, while the decrease in gasoline prices is a good thing in terms of the consumer’s expense on gasoline, it may not be really great news in that it could be a result of the economic slow down which could mean higher unemployment, slower income growth, etc. Or as Prof. Hamilton puts it,
Three cheers for falling gasoline prices? At least one, yes, but you might want to keep a couple more in reserve as we wait to see how this plays out.
This strikes me as the right take on the situation.
