• Lower oil prices will likely increase US GDP growth by around 0.3ppts in 2015, a bit less than we initially expected
• The costs and benefits are unevenly distributed among states, with the less diversified states having the largest impact
• Together with the strong dollar, lower oil prices have pushed down core goods prices, but core services inflation has been slowly increasing
After more than a year of sinking oil prices, we assess the impact that this has had for the US economy so far and the expected outlook. We had been quite optimistic about the benefits of lower oil prices, it seems that there was some delay, but our assumptions seem to be falling into place now.
Consumers initially saved gains from lower oil prices
The decline in the WTI to USD 40 today from USD 107 in June 2014 has resulted in a net positive for the US economy so far, but the magnitude is smaller than we initially expected. To begin with, the boost to consumption from lower gasoline prices and higher disposable income took a little longer than we expected. In a note we published early this year, we estimated that the gains for US household disposable income should amount to around 1% of GDP. This estimate was made considering a fall of 40% in gasoline prices, which is just about right. Were we were wrong is that consumers did not spend the windfall gains from lower gasoline prices in the first half of the year. Consumers preferred to save. The personal savings rate increased from 4.6% in August to 5.4% in the first quarter, but has been slowly declining since then (4.8% in September). For 2015 as a whole we expect lower oil prices to contribute 0.6 ppts to GDP growth, as households spend their windfall.
Investment spending falls by 0.3ppts of GDP
On the other side, declining oil prices have resulted in a slowdown in investment spending. But this slowdown was initially more modest than most expected. Indeed, in late 2014, estimates suggested that the oil breakeven, or the price at which it would not be profitable to drill was around USD 60. However, reality is more complex. Investments from energy producing firms are not based on the spot price, since existing projects take into account longer-term price estimates and the trend in future oil prices is expected to gradually increase . Moreover, firms have been making efficiency gains to reduce production costs lately. This has kept production steady despite the lower oil prices for a while. Only recently, the US rig count has fallen sharply and with it investment in energy structures has been declining. We expect this will continue until the end of the year. If we look at investment spending in the energy sector, it totalled USD 144bn in Q4 2014, falling to USD 75bn by Q3 2015. If we attribute this decline to the fall in energy prices, then this would amount to USD 69bn, which is around 0.3ppts of GDP.
Impact on employment varies across states
As for employment, energy related activities are quite small in comparison to total employment (0.62% of total private employment). Data from the Bureau of Labor Statistics shows that the direct losses in employment have amounted to around 100K in the past year, meaning that the direct impact on the overall economy has been modest. However, when looking at the states compositions, the states with the highest shares of energy employment are Alaska, Louisiana, New Mexico, North Dakota, Oklahoma, Texas, West Virginia, and Wyoming. This suggests that there is some concentration in a few states of energy-related employment. Wyoming is the less diversified and Texas has one of the most diversified economies from this group. These more vulnerable states will likely see economic activity soften and their state budgets weaken, as one of their income sources declines. The Dallas Fed suggests that non-oil producing states will likely benefit, since less expensive fuel will lead to more capital investment and more hiring 1/ .
Consumer prices only temporarily below target
The impact on inflation of falling oil prices is seen as temporary, as long as prices stabilise at some point. This should push headline inflation to around 2% in the course of 2016. Headline inflation has fallen by 2ppts since oil prices began their decline. The extent to which lower energy prices affect other components of overall inflation depends on the persistence. Until now, lower energy prices which often represent a considerable share of production costs via transportation, have been putting downward pressure on core goods. The strong dollar has also played a role here. Meanwhile prices of services ex-energy and ex-shelter have been edging up, likely as a result of the increasing demand for services, resulting from higher disposable income and lower gasoline prices. Under the current circumstances, we find it is more appropriate to focus on core inflation (which excludes energy and food) to assess any potential risks of inflation falling too far below its 2% target.
As we mentioned lower oil prices boost domestic demand as households spend their windfall. On balance there is an upside risk to growth, as long as confidence remains strong. Only if core inflation, that strips out energy and food begins to trend down, then there is a downside risk for consumers and then it would mean that there are other factors besides low oil prices, including lower inflation expectations, that are pulling down inflation. We expect core inflation to gradually increase in the coming time as domestic demand gives the economy the necessary impulse, on the back of stabilizing oil prices.
1/ Dallas Fed, Economic Letter, Vol 10 No. 3, April 2015