In the past few years, the U.S. economy has grown at a healthy pace in the face of a relentless rise in energy prices. However, almost all analysts agree that continued energy price increases will affect the overall economy and employment, and might affect different sectors of the economy in different ways. This paper examines the possible effects of an energy price rise both at the national and industry level.
We modeled how the U.S. economy would react to a permanent spike in the price of oil of $20 per barrel and a permanent spike in the price of natural gas of $2.00 per thousand cubic feet (mcf) in 2006. This means that we assumed that oil prices remained $20 per barrel higher than would otherwise be assumed in a macro-economic model (i.e. $20 above their baseline prices) through 2020 and natural gas prices remained $2.00 higher than their baseline prices, but that their annual price rates of change follow their respective annual price growth path of the baseline—a “permanent” spike.
The baseline oil price is between $50 and $60 per barrel for West Texas Intermediate (WTI) in 2006. The $20 per barrel price increase therefore translates to a per barrel price of between $70 and $80. (Note that, in fact, the price of WTI crude oil has been above $70 for most of the time between mid-April and mid-May 2006). The $2 increase in the natural gas price translates to between $8.00 and $9.00/mcf, wellhead price, in the next few years—compared to a baseline price of between $6.00 and $7.00/mcf. (The actual wellhead price of natural gas dropped from $10.00/mcf in December of last year to $5.51 in September.)
We conclude that these levels of higher energy prices: (1) cause the economy to grow more slowly in 2006 and 2007, but not cause a recession; (2) reduce the growth in industry output and job creation across the economy as domestic income is transferred to foreign oil producing countries; and (3) induce U.S. energy consumers to use less energy in the long run.
In particular, we found that—
• In 2006, real Gross Domestic Product (GDP) growth slows by almost 0.5 percentage points below the baseline growth. In the second year, growth falls by another 0.2 percentage points. Given the strong momentum of economic growth, such slowdowns are far from what it would take to induce a recession. After 2007, real GDP growth rates more-or-less follow the baseline forecast through 2020.
• The unemployment rate is almost 0.5 percentage points higher in 2007, at the height of the labor market impact. After 2007, the difference in the unemployment rate declines—by 2010, there is only about a 0.2 percentage point difference.
• Compared to the baseline, the higher energy prices push up consumer price inflation (i.e., the personal consumption expenditure (PCE) deflator) by one percentage point and 0.6 percent points for 2006 and 2007, respectively. By 2008, however, inflation is back to baseline rates.
• Industrial output growth is affected adversely across the board. Higher energy prices slow down growth of output in most industries regardless of their energy intensity. However, most industries continue to grow—even if at a slower rate.
• Higher energy prices mean that the number of jobs that the economy creates is reduced. In this scenario, instead of creating 1.9 million new jobs in 2006, the economy creates 1.4 million new jobs—a difference of 500,000 jobs. In 2007, the economy loses another 200,000 jobs compared to the baseline. Missing jobs peak in 2007 at around 700,000.
• The largest economic impact comes through the loss of consumers’ real disposable income. Higher crude oil prices act as a tax on real purchasing power, and the proceeds of this tax are spent abroad, reducing the purchasing power of the economy as a whole.
• Since we assume that the energy price shock is global, higher energy prices do not result in an appreciable loss of foreign competitiveness in energy intensive sectors. Nonetheless, since U.S. producers of tradable goods are slightly less energy efficient than their foreign counterparts, over the long run, the trade-weighted U.S. dollar will depreciate by about 2 percent in order to restore competitiveness on a global cost basis.
• Wholesale and Retail Trade, Finance and Insurance, and Construction are the industries with the greatest absolute employment impacts. The Energy, Transportation, and Durable Manufacturing industries have the largest output and employment effects relative to their size.
• As stated above, broadly-based reductions in real income account for the bulk of jobs reduction in general consumer-related industries such as Wholesale trade, Retail trade, and Construction. Therefore, in general, jobs impacts by state are proportional to the size of these sectors for each state, which are, in turn, roughly proportional to each state’s employment share. Thus, California, Texas, New York and Florida lose the most jobs, in that order. Pennsylvania, Ohio, and Illinois come in close together at fifth place.