Print

Mail

wiki links

Slipping oil price may fuel growth

Cheaper oil could provide just the tonic the world's battered economy needs as it confronts a looming recession expected to hit next year.

Oil prices plunged to a two-year low of US$16.80 per barrel on Thursday and have steadily defied fears that they would soar to US$50 per barrel or more after the Sept. 11 attacks on the US.

The fall occurred after OPEC delayed implementation of a 1.5 million barrel-per-day cut on output to apply pressure on rival producers. This is bad news for oil exporters, but it is very good news for the rest of the world.

Cheaper oil has the virtue of boosting demand without igniting inflation, which means that central banks can keep on cutting interest rates as growth slows.

"Lower oil prices puts money into the pockets of people who buy things produced with oil and provides a potentially significant demand boost," said Professor Paul Seabright at Toulouse University in southwest France.

That is, if consumers spend the extra cash that a fall in oil prices delivers. So oil will only help if confidence returns.

Horror at the destruction of the World Trade Center and the unravelling of a huge technology investment bubble has crimped consumer and business demand and threatens the world with its first serious slowdown in a decade, the IMF warned on Thursday.

But central banks on both sides of the Atlantic have slashed borrowing costs to restore confidence. If a record leap in October US retail sales is any guide, the strategy is working -- and cheaper oil will give their efforts a crucial boost.

Economists at the OECD estimated in September that the positive supply shock of a 50 percent fall in the price of oil would add 0.3 percent to US economic growth in the first year and lop half a percentage point off its rate of inflation.

In the euro zone and Japan the boost to growth is 0.4 percent in year one and the downward impact on inflation 0.6 percent and 0.4 percent respectively. And the benefits flow through pretty fast.

"The maximum impact on prices is seen during the first six to 12 months," said economist Christpohe Andre at the Paris-based Organization for Economic Cooperation and Development.

Others argue the impact could be more substantial, including Professor Andrew Oswald, an oil expert at Warwick University, who two years ago predicted a world recession when oil prices surged above US$35 per barrel. It currently stands at US$18 per barrel.

"Oil has now halved from its peak. If it stays around here, that would be enough to add around 2 percent to world employment. This could be an enormous benefit to the world economy," he said.

Jobs have been in the firing line of slowing growth with unemployment surging above 5 percent in the US and mounting almost every month this year in Germany. Unemployment saps confidence and spending, but this works in the opposite direction when new jobs are created.

"It takes about 18 months for a big movement in oil prices to impact the real economy so I still think we are going into a recession in the coming months, but I think it will be short-lived," Oswald said.

The IMF forecast world growth of 2.4 percent next year, falling short of the 2.5 percent threshold that economists say is needed to keep the world out of recession. Economists at CSFB estimate that a US$10 fall in the price of a barrel of oil would add 0.5 percentage points to world growth, pushing it back above this threshold.

True, oil dependence has changed a lot since the crisis of 1973 when OPEC held the world at ransom over prices and set in motion one of the longest recessions in 50 years.

Economists estimate the use of oil in the European economy has shrunk to between 1 percent to 2 percent of GDP, versus 2 percent in the US and 3 percent in non-Japan Asia. Back in the 1970s, industrialized countries' oil and gas consumption was 5 percent to 6 percent of GDP.

But the impact of oil remains an important ingredient in the recipe for economic output, affecting profit margins in sectors like the airline and chemicals industry or the demand for cars, in addition to general household spending power and inflation.
This story has been viewed 4180 times.