Federal Reserve Chair Janet Yellen raised more than a few eyebrows in a Mar. 29 speech by highlighting oil prices at less than $30 per barrel as a development that "would tend to restrain U.S. economic activity."
While lower oil prices bring about a front-loaded hit to growth — as energy-producing firms respond by curtailing investment and employment — the net effect of lower oil prices was expected to be positive, with a lag. After all, cheaper fuel prices are considered a form of stimulus for the U.S. consumer, the largest segment of the economy. And despite the shale revolution, the U.S. remains an oil-importing nation.
Yellen later clarified that lower oil prices "likely will boost spending and economic activity over the next few years," explaining that the downside risks of low prices potentially reflected "market concern that the price of oil was nearing a financial tipping point for some countries and energy firms." If crude fell below this tipping point, it would prompt spillovers from abroad and further financial market turmoil that could adversely affect the U.S., she explained.
But David Mericle and Daan Struyven, economists at Goldman Sachs Group, make the unconventional argument that higher oil prices would be a boon for U.S. growth by breaking down the three major avenues by which the level of crude impacts growth: investment, consumption, and trade.
The pair analyzed three scenarios in which Brent oil prices either fell to $30, recovered to $50, or rose to $70 by mid-2017 and stayed there for the year and a half, and the outcomes for the U.S. economy from 2016 through 2018 under each case.
Getting prices back to around $45 to $55 per barrel would provide a meaningful boost to U.S. capital spending, the economists note, as the breakeven prices for the three largest shale plays in the nation fall in this range.
If Brent returns to $70 per barrel by mid-2017, gross domestic product would be roughly 0.4 percentage points larger by the end of 2018 than if crude sank to $30 per barrel, according to Goldman's calculations.
But if oil prices stay lower for longer, the U.S. consumer is the clear winner. While the extent to which households have elected to save rather than spend this energy windfall has proved surprising, Mericle and Struyven point out that "the consumption impact is likely less immediate and more prolonged than often assumed."
Should crude stay at $30 per barrel, consumption is estimated to be 0.4 percentage points higher by the end of 2018 than under the $70 per barrel scenario.
The cumulative effect of these two channels suggests that for U.S. growth over the next three years, there's no difference between oil at $30 or $70 per barrel. How the trade balance responds to swings in crude will dictate which path is more desirable.
Oil consumers are unquestionably sensitive to swings in the price of gas — vehicle miles traveled in the U.S. kicked into high gear as the cost of filling the tank tumbled. But U.S. oil production is even more price elastic — that is, when oil prices fall, domestic production declines by more than consumption rises, according to Goldman. Therefore, the U.S. has to import more oil.
"The petroleum trade balance channel amplifies the capex channel," the economists write. "The petroleum trade deficit would be wider in the $30 scenario than in the $70 scenario, an effect worth about -0.4 percentage points on GDP."
Here's how Mericle and Struyven see the U.S. economy faring amid a period of oil at $30, $50, or $70 per barrel over the next few years:
"In short, our analysis implies that lower oil prices have become 'too much of a good thing' for the U.S. economy," they explain. "In the sensitive range where oil prices now lie, the nonlinear impact of oil prices on energy sector capital spending and the petroleum trade balance outweigh the steady per-dollar impact on consumption."
The economists acknowledge that there are a variety of other channels (like lower input costs for businesses or the aggregate effect on high-yield spreads) that aren't discussed in this report, but deem any of these effects to be "more uncertain, more diffuse and likely smaller than the three main channels discussed above."
Central bankers in advanced economies have found themselves in the odd position of hoping for higher oil prices to avoid inflation expectations becoming unhinged to the downside. According to Goldman, it looks like U.S. economists looking for better growth find themselves in this similarly unfamiliar position.
On the other hand, employment would benefit more from a period of oil prices at $30 per barrel than at $70, according to Mericle and Struyven. This argument entails that the collapse in oil prices has exacerbated the trend of sluggish productivity growth stateside, as energy extraction is a capital rather than labor-intensive industry.