Monday, November 24, 2008

GDP Effect Of Lower Oil Prices

US GDP is estimated at over $14 trillion. Exports make up around $2 trillion of this amount, as international demand for products and services provided by Americans contributes to the US economy. At the same time, imports subtract from GDP (though there are mitigating secondary and tertiary effects the magnitude of which economists love to debate) to the tune of $3 trillion. With the recent drop in oil prices, can we approximately measure the effect on US GDP going forward? We can make rough estimates, but there are complications that make an exact answer impossible.

According to the Energy Information Administration, the US imports approximately 12 million barrels/day. With oil at $95/barrel last November versus $55 for November 2008, this represents a positive effect on US GDP of $175 billion at an annual rate, or 1.3% of GDP. Considering annual GDP growth is approximately 3% per year, this is not insignificant.

However, there are complications which threaten the accuracy of this rough calculation. First of all, when Americans send money abroad to import oil, some of that money flows back to the US in the form of equipment purchases, technical expertise or any other goods and services that Americans provide, which dampens the subtractions to GDP.

Furthermore, if Americans are not spending that money on oil, they might spend some of it on another imported product. Therefore, the savings from the drop in oil might still flow out of the country for the purchase of another good or service, which would serve to further lower our estimate for how much GDP would benefit from lower oil prices.

However, for the money no longer spent on oil that is spent on domestic goods and services, there is a multiplier effect, as the domestic providers of these goods and services will then spend a portion of their receipts on more goods and services (a portion of which will be domestic), which has the effect of increasing GDP to a level higher than our rough calculation.

Economists disagree on exactly what the final effects of such secondary and tertiary effects might be. But finally, it's important to recognize that oil is not the only major factor that will contribute to upcoming GDP growth numbers. If people are effectively storing their money in mattresses due to low consumer confidence, as we saw here, this will have a far more profound impact on GDP than changes in oil prices.

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