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Cheap energy and the economic boom.

The U.S. economy owes much of its success over the last seven years to cheap gasoline and petroleum products. It's true that high energy costs, along with high interest levels, helped make the two recessions of 1979-1981 worse. But since that time energy prices have plunged, and the economy has boomed. Cheap energy helped get the economy through the stock market crash of 1987, through the continuing savings and loan crisis, and it kept the minor downturns in construction, real estate, and manufacturing from threatening the long-lived economic boom.

Will the economic boom continue for 1990? The answer largely depends on the price of energy for the next year or two. The cheaper energy of the 1980s was an inconspicuous source of consumer confidence in the economy. Usually, one looks to interest rates, employment, and wage rate growth to see whether or not consumers will have the power to purchase the goods and services available for the next year. But energy, in the forms of gasoline and utilities, is a critical component of consumer purchases.

Changes in energy prices have a two-part impact on economic growth. First, as energy prices fall, consumers spend less of their incomes to buy the Same amount of energy. Consumers find they have extra spendable income. Second, energy is an integral part of many plastic products and essential to many services. A price decline in energy means many other products and services will be cheaper to buy. From 1982 through 1988, consumers were able to shift expenditures from energy products to many other goods and services, helping to spur growth throughout the economy.

Just how inexpensive is energy today? Figure 1 plots the percentage of all personal consumption expenditures spendable income) used for household utility expenses and for automobile gasoline and oil expenses. During the sixties, Americans spent proportionately less each year for utilities and gas. Of course, the energy crisis of 1973-1974 changed all that. Utilities and gas became an increasingly important aspect of our monthly bills.

But a big change started in 1981-1982. Relative to total consumption spending, utility and gasoline expenditures claimed less and less of our income. As the economy grew out of the recessions of the late seventies, energy inflation became a thing of the past. By the end of 1988, gasoline was claiming considerably less of our personal consumption expenditures than in 1965. Utility charges had also fallen relative to our growing incomes.

However, consumers aren't usually aware of the percentage of income that they spend on gasoline. They think in terms of the price at the pump. Although the price has been higher, gasoline still costs close to $ 1.00 per gallon. That is a lot more that the 25 to 30 cents per gallon that the consumer paid for gasoline in the 1960s. Or is it? After all, we have been through a lot of inflation, and all those years of inflation mean that the dollar of 1989 really only buys what 30 cents could buy 20 years ago.

In 1967, 10,000 gallons of gas cost 70 percent of the price of a new car. This ratio rose to 180 percent by 1981. Since then, it has fallen to the 70 percent range. nat is, gasoline, relative to the price of a new car, is as low as it was in the 1960s.

In addition to the decline in gas prices, energy efficiency has been an important factor in the economic health of the 1980s. For example, the miles per gallon of the average new car rose from 13.6 in 1970 to 24.3 in 1980 to 28.7 in 1988. Low gas prices and energy efficiency made automobiles much cheaper to operate on a day-to-day basis.'throughout the economy, the conservation measures of the 1970s, coupled with low energy prices, paid off in significant economic growth incentives for the 1980s.

During the 1970s, energy prices were so high that it was expensive to purchase a product that used a lot of it. Many consumers made do with old cars, and others bought cheap, energy-efficient ones. When gasoline prices fell in the 1980s, consumers sold their old vehicles and purchased new ones in record numbers.

As Figure 3 confirms, real GNP grew as real gas prices fell. For many years during the 1970s, gas prices seemed to be the cause of inflation. But during the 1980s, falling oil prices actually helped dampen the inflationary pressures in the economy. The impact rippled through the entire economy. Products and services associated with energy usage became part of the boom. Shopping developments bloomed as consumers had more gas to drive to the malls and more money to spend once they were inside.

Can gas prices really be used to predict GNP? Figure 3 [omitted] illustrates what happens if you use real gas prices to forecast GNP using regression techniques. In fact, there is a very close relationship between the actual GNP of the 1980s and the GNP predicted by real gas prices. Therefore, gas prices are an excellent indicator of the health of the 1990 economy.

During 1989, energy prices slowly flowed upward. And if gas prices stay as high as they were in 1989, a recession is predicted. West Texas crude stayed close to $20 per barrel during 1989. And OPEC prices stayed in the $15 to $20 range. This year-long increase in energy prices has helped make current troubles in the automobile sector worse.

Me economy in the last year of the decade was not as prosperous as in previous years. Acrucial determinant of sluggish growth in 1989 was rising oil and gasoline prices. The price of gasoline was back to 1985 and 1986 levels. The prices of energy, home heating, and air transportation are all being driven up by higher energy prices. The result has been a stagnation in the economy, particularly in manufacturing, a sector which has actually seen declines in industrial production for the first time in several years.

The economy of the early 1990s will be influenced by many factors. Interest rates, financial stability, debt levels, and the balance of international trade will all either help or hinder the future growth of the economy. But the energy factor is critical. Our industrial economy is dependent on inexpensive energy for the continued growth of both its industrial and service capacity.

Fortunately, the outlook for 1990 is bearish for oil prices. And that may mean that the economic boom may have some life left in it. Oil production is strong and reserves are adequate, even though demand has not grown rapidly in the past two years. The outlook for 1990 is for abundant energy sources and low energy prices, comparable to 1988 levels. If energy prices return to those low levels and fall through the early 1990s, the U.S. boom of the 1980s could continue as the longest period of economic growth in our history.

But current signals show a recession for 1990. How bad will the recession be? That will depend on many factors, with energy prices playing a key role.

Dr. Ciscel is professor of economics and associate dean for graduate programs at Memphis State.
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Title Annotation:energy prices and the U.S. economy
Author:Ciscel, David H.
Publication:Business Perspectives
Date:Dec 22, 1989
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