You Decide: Are low oil prices good or bad for the economy?

Dr. Mike Walden
North Carolina Cooperative Extension

I’ll be honest – I didn’t think I’d see it in my lifetime. I’m talking about gas prices being under $2 per gallon. It’s one of the true “good news” items in the economy.

Or is it? A funny thing has happened on the way to the gas pump. The more gas prices have dropped, the more concerns there seem to be about the economy. Since the beginning of the year the stock market has taken some big hits. And although we’re only a few weeks in to 2016, most economic forecasters have already lowered their growth projections for the year.

Of course, gasoline is a direct derivative of oil, so we’re really talking about lower oil prices. Oil prices are down almost two-thirds since mid-2014. But aren’t low oil prices supposed to be good for the economy? Remember the 1970s, when jumps in oil prices sent the country into two recessions. And even more recently when oil prices were over $100 per barrel, many analysts loudly stated how much better the economy could be if oil prices would just fall.

But today seems to be different. The stock market appears to rise when the price of oil rises, and the stock market falls when the oil price falls. What’s going on? Have the rules of economics been turned on their head?

There are three alternative reasons given for this confusing situation. One is that the U.S. economy is different today, with the nation now being an energy-producer rather than only an energy-consumer. So when the price of oil falls, it hurts production, incomes, and employment in the country.

The second explanation revolves around what has caused oil prices to plunge. Did they drop because of increases in supply – which most would say is good – or from decreases in demand (buying) – which could be interpreted as signally a weak economy?

The third explanation comes from a tossup. Some economists are throwing up their collective hands and saying, “This doesn’t make sense.” Their best story is that, with the gains the economy and the stock market have made in the last seven years, it’s been time for a pause.

Let’s look at the three explanations in more detail. Most economists dismiss the first explanation – that since the U.S. is now again a major oil producer, lower oil prices can hurt the economy. Total employment in oil and gas extraction accounts for only one-tenth of 1 percent of all U.S. jobs and about 2 percent of national production. Plus the industry is concentrated in only a handful of states, like Texas, North Dakota and Oklahoma, but not North Carolina.

Furthermore, there’s the benefit lower oil prices have on households and businesses – mainly from cheaper gas for driving. Using the results from published research, I estimate the North Carolina economy has added 52,000 jobs since 2014 as a result of lower oil and gas prices.

The second explanation requires a look at the two major elements of economic analysis – supply and demand – in this case supply and demand in the world oil markets.

There’s no question that the world supply of oil has been increasing in recent years. Since 2008, oil production in the United States has doubled, and our country is now again a major world oil producer. Iraq has more than doubled its oil output in the last decade, and soon Iran will be selling more oil as sanctions against it are removed.

But while most countries have begun to use more oil and oil products as the Great Recession ended, one important country is bucking this trend – China. A decade ago China was increasing its annual consumption of oil by double-digit rates. Last year its oil usage rose only 1 percent, and many think China’s oil consumption could soon be falling.

While this trend could be applauded as good news – for the environment, for oil prices, and for use of a limited resource – others worry about the reason China is using less oil. What they see is a Chinese economy that is seriously slipping. With its pool of cheap labor ending, some manufacturers have moved to other countries. Construction has almost stopped as many new developments stand unoccupied. In short, the Chinese economic engine – once the envy of the world – has been sputtering to a halt.

And while U.S. exports to China are relatively small, China is still the second-largest economy in the world and a major investor in other countries, including the United States. So when China sneezes, investors everywhere worry.

Still, some economists are unconvinced that low oil prices or a Chinese economic slowdown are enough to crimple the U.S. stock market. Instead, they see the recent drops in the stock market as simply an old-fashioned “correction.” With the stock market today at almost triple its value during the Great Recession, and with the current economic recovery now approaching seven years old, some experts say it is just time for a pullback.

Regardless of which explanation is correct, the volatility in the stock market this year deserves watching. Even if you’re not an investor, changes in the market can impact the economy, companies, and even your job. I – like many – will continue trying to decide where the economy and stock market are headed next. It may be a wild year!

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Dr. Mike Walden is a William Neal Reynolds Distinguished Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of North Carolina State University’s College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy. His You Decide column comes out every two weeks.

Previous columns are available at http://www.cals.ncsu.edu/agcomm/news-center/tag/you-decide

Related audio files are at http://www.cals.ncsu.edu/agcomm/news-center/category/economic-perspective

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