By Caroline Baum
Few commodities are imbued with the mystical powers of oil. It has the ability to administer fiscal policy, and it provides the same effect on economic activity as the central bank's interest rates. Just listen to some of the half-baked "analysis" that accompanies any sharp rise in oil prices and see if you don't agree.
Let's start with oil's relationship to the economy. When oil prices rise, some economists claim that it's a "tax" on consumers. Never mind that a tax drives a wedge between consumers and producers, creating a dead-weight loss. I hope these PhD's know the difference between a tax and a change in price and are using the term "tax" as a figure of speech.
Then there's oil's asymmetrical impact on growth. "When prices go up, it's an economic drag. When prices go down, it's disinflationary," says Stephen Stanley, chief economist at Pierpont Securities in Stamford, Connecticut. The Fed's "heads I ease, tails I ease" relationship with oil has persisted for at least a decade, Stanley says.
I made the mistake of listening to a panel of journalists discuss the recent spike in gasoline prices (the national average is now $3.76 a gallon, according to AAA). One explained the ebb and flow this way: When gas prices rise, people drive less. When people drive less, gas prices fall.
In other words, higher prices cause lower prices; lower prices cause higher prices. This is loop-de-loop analysis at its best.
What this person was describing is an individual's demand schedule, reflected by a downward sloping demand curve. As the price of a good rises, demand generally falls, and vice versa. That describes the relationship between price and quantity demanded.
What caused gas prices to shoot up this year is increased demand for oil and gas at any given price, arguably a result of anticipated supply disruptions from the Middle East. That relationship is expressed as a shift out in the demand curve.
If it's too hard to grasp the difference between higher prices and a tax, then maybe understanding the law of supply and demand is a bridge too far.
(Caroline Baum is a Bloomberg View columnist. Follow her on Twitter.)
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-0- Mar/08/2012 19:36 GMT