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September 21, 1990
"Absorbing the Oil Hike - U.S. May Be Able to Avert Recession"
San Jose Mercury News
By Timothy Taylor
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AS oil prices rise, it looks more and more as if the United States is destined to repeat the gloomier bits of recent economic history. Play it again, and watch the economy run into its two most recent recessions.

It's November 1973. The gross national product has been growing at 5 percent faster than inflation for two years, and the unemployment rate has just fallen to 4.7 percent, from a level of 5.9 percent in January 1972.

In fact, this fast-growing economy seems on the verge of overheating, and entering an inflationary spiral. President Richard Nixon temporarily slowed the growth in prices by imposing wage-and-price controls in 1971, but inflation is already running above 8 percent during the first three quarters of 1973.

Then, like a lightning bolt, OPEC decides that the time has come for the West to pay more for crude oil. The price that oil refiners pay for their crude nearly triples, from $3.60 per barrel in 1972 to $10.40 a barrel in 1975.

The U.S. economy actually shrinks 2.7 percent during the resulting recession, which lasts until March 1975. Inflation hits double-digit levels in 1974, and unemployment rises to 8.3 percent by 1975.

Fast forward. It's January 1980. The economy has been growing at about 3 percent faster than inflation during the previous two years, and unemployment has been holding steady at around 5.9 percent for a year and a half.

But thanks to sharp increases in the price of crude oil, inflation is on a rampage. Crude oil prices had crept up to $12.50 per barrel by 1978, but then tripled to $37.30 per barrel by February 1981. Although inflation had fallen to about 6 percent in 1976 and 1977, it averaged nearly 12 percent per year from 1979 to 1981.

The Federal Reserve broke the back of the inflation by restricting the money supply, a policy that also pushed up interest rates and shoved the economy deep into recession. Adjusted for inflation, the U.S. economy was actually 1 percent smaller in 1982 than it was in 1979.

Fast forward again, this time to the present. Oil prices have risen from about $19 per barrel at the start of August to over $30 per barrel. It looks frighteningly like one more chorus of the same old song, those oil recession blues. Fortunately, history is not predestination. There is at least a possibility that the U.S. economy might be able to scrape through the current rise in oil prices without a recession.

So far, oil prices have risen by about two-thirds. This is a hefty hike, but it's proportionately far less than the tripling of oil prices that happened twice during the 1970s. In fact, since overall inflation has increased about 40 percent during the 1980s, crude oil prices would have to hit $50 per barrel today to equal the $37 per barrel oil of 1981.

Moreover, the economy learned how to cope with higher oil prices, at least to some extent, during the sharp price rises of the 1970s. For example, total U.S. oil consumption declined 16 percent from 1978 to 1986, even though the number of Americans and the economy grew in size. All those energy- efficient buildings and appliances, home insulation and more efficient cars continued to save energy even when the price of oil fell in the mid-1980s, and they are cushioning the effects of the latest increase.

Taking into account the smaller rise of oil prices and the improved ability of the economy to cope with such increases, the standard estimates are that current oil prices might push the 1991 inflation rate up by 2 percent, and would slow economic growth by less than 1 percent. That's not happy news, but it's not an actual recession, where the economy shrinks in size.

Not quite.

Of course, even if the nightmare economic scenario isn't here yet, it's far too close for comfort. Although unemployment has recently been holding at a reasonably low 5.3 percent and inflation has been holding steady at about 5 percent, economic growth has been quite weak, at less than 2 percent for the last 18 months. With a slower growth rate than in 1973 or 1979, a smaller bump from oil prices may be sufficient to tip the economy into recession.

If that happens, economic policy makers will have less room for maneuvering, because of the budget deficit. During the recessions in 1975 and again in 1981, taxes were cut to stimulate the economy. But the budget deficits of the early and late 1970s were only about 2 percent of GNP. After a decade of running enormous budget deficits, and with the deficit still looming at 3.5 percent of GNP, cutting taxes is not as attractive an option.

If I were a betting man, I'd lay five-to-four that the U.S. economy can stagger through without a recession if crude oil remains at around $30 per barrel. But if a war in the Middle East puts the Saudi Arabian oil fields out of production, then all bets are off.

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