Increased U.S. oil production, combined with falling oil demand in emerging markets and more uncertainty in the European Union, recently caused oil supplies to rise faster than demand. That pushed world oil prices to six-year lows.
By mid-January the price of crude oil fell below $40 per barrel— a decline of more than 50% from year-ago levels. At the pump, this translated to a 35% slide in the price of a gallon of unleaded gasoline. Although gas prices have risen somewhat since, they remain well below the year-ago average.
Oil, of course, is a key factor of production—both in the manufacturing and service sectors. So lower oil prices mean lower production costs and, by extension, more economic growth.
That’s good news because there’s room for economic growth, and most labor markets, despite improvements, will take time before they’re completely healed. From a consumer perspective, energy price increases change consumer outlays (consumers drive the same distance to work every day) and leave less money available for discretionary spending (more gas expenditures mean fewer trips to the restaurant).
Rising oil prices, therefore, don’t typically cause a big decline in overall consumer spending. They simply shift expenditures from one commodity to another.
In contrast, energy price decreases tend to have the opposite effect, allowing members to spend less on energy and more on other things.
It’s not easy to predict specific changes in consumer purchasing behavior arising from energy price changes because those effects have varied dramatically over time. But some things are clear.
First, energy price declines perceived as longer lasting can dramatically boost consumer confidence and can, therefore, increase consumer demand for goods, including big-ticket items such as automobiles.
That’s important because consumer spending accounts for 70% of U.S. economic activity—and many consumers finance big-ticket purchases with credit union loans.
Second, positive economic effects associated with lower energy prices tend to be more dramatic when both interest rates and inflation expectations are low, as they are now.
The federal-funds rate is expected to remain below 0.10% through most of the first half of the year. Further, the Federal Reserve Bank of Cleveland’s latest estimate of 10-year expected inflation is 1.8%— well within the Federal Reserve’s 2% inflation target.
On the other hand, oil price declines cause higher unemployment in areas of the economy dependent on the energy sector. If oil prices stay low for an extended period the effects can be severe, spilling over to other industries.
Lower prices also affect the revenue stream of the U.S. oil industry and, consequently, lower the industry’s planned investment spending. In 2013, the U.S. oil and gas extraction industry had a $204 billion impact on gross domestic product. Lower investment spending by this industry can, therefore, have a big effect on employment and income.
In addition, collapsing oil prices might threaten the stability of international producers. And that, in turn, could have a destabilizing effect on financial markets.
While consumers and businesses respond to market signals, it’s important that oil prices stabilize at a level consistent with the macroeconomic goal of long-term price stability. If that happens, the economy, consumers, and credit unions will benefit.
Overall credit union loans grew 10.2% during 2014, led by an astounding 21% increase in new auto loans. Our baseline forecast puts 2015 loan growth at 11%.
Recent energy sector developments might require an upward revision to that rosy outlook.
PERC PINEDA is CUNA’s senior economist. Contact him at 608-231-4285 or at email@example.com.