June 27, 2006

Oil Prices and Consumer Confidence

Will oil prices stay at current levels, and how will they affect consumer confidence and the economy as a whole?


Marc Giannoni, Associate Professor Finance and Economics:

Oil prices should remain high in the near future, as long as the world economy continues to expand fairly rapidly, thereby stimulating demand for oil. However, short-term predictions of oil prices are difficult because they depend in part on political factors, such as stability in the Middle East. In the United States, higher energy prices as well as rising interest rates have tended to reduce consumer confidence. But consumer confidence has also benefited from a rapidly expanding economy and improved labor market conditions. Because of these opposing influences, consumer confidence has been quite volatile recently.

Unless other important negative news arrives, I expect that in the near future consumer confidence will remain relatively high, as the economy continues to grow at healthy rates and the labor market remains strong. It is likely, however, that high oil prices and a strong economy will induce the Federal Reserve to raise interest rates further in order to contain consumption and residential investment. This may have a negative effect on consumer confidence.

 


Frederic Mishkin, Alfred Lerner Professor of Banking and Financial Institutions:

If you manage other policies well, oil prices are not as big a deal as people think. In the 1970s, the Federal Reserve didn’t do a good job of keeping inflation under control, and when oil prices went up, it had a much, much greater effect. It led to higher inflation, and higher inflation means the central bank ends up tightening monetary policy to cope with it, with a negative impact on the economy. In recent years, the higher credibility of the Federal Reserve to control inflation has meant that oil prices have not had the same kind of negative effect.

 


David Beim, Professor of Professional Practice, Finance and Economics:

Although we’re seeing relatively high oil prices compared to recent years, the rise does not seem to have slowed down the economy. But it has provoked discussion of alternative sources of energy, which is a very positive development. Interest in ethanol has greatly accelerated in the last year, especially ethanol derived from cellulose. The competitiveness of Canadian tar sand oil has also improved — that’s a huge resource but expensive and difficult to access. It becomes more realistic with higher oil prices. There’s also a new process to make diesel fuel from coal; the governor of Montana is devoting a lot of time to promoting that process.

The rise in oil prices is actually good because it will accelerate our development of such alternative sources of energy. We must rapidly reduce our dependence on oil imports, especially from the unstable Middle East.

 


Glenn Hubbard, Dean and Russell L. Carson Professor of Finance and Economics:

Tightening supply reflects continued low production in Iraq, supply disruptions in Nigeria and investment-unfriendly politics in Venezuela and Bolivia. At home, regional variations in environmental standards and recent mandates for blended ethanol that exceed production squeeze gasoline supply and raise prices. On the demand side, we in our SUVs make too little effort to encourage energy efficiency. And abroad, China has leapt past Japan as the world’s No. 2 oil consumer.

But the cure for high prices is…high prices. High prices encourage conservation on the demand side. They also encourage the development of new oil reserves and, importantly, alternative energy sources on the supply side. We need to support basic research for new technologies and export energy-efficient techniques to emerging economies. We need to clear out harmful domestic barriers to production and refining. And at the broadest level, we need to coordinate the domestic and foreign policy sides of the nation’s energy policy.

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