Energy and the Next Recession

I'm working on a couple of more interesting and original posts but (lack of) time is the key factor delaying them. In the meantime, here is a quickie macroeconomics lesson on energy price and consumer spending.

It seems that increased energy costs, while taking a bite out of the consumers' wallets are affecting producer prices even more. In an article in the Gray Lady on October 18, we find the following report:

Wholesale prices surged at a faster pace than consumer prices last month, the government reported today, indicating that businesses are not passing on the full brunt of the energy price spike to customers but may soon start doing so.

The producer price index, which measures the prices received by producers of goods and services, jumped 1.9 percent in September, the fastest monthly increase since January 1990, as energy costs rose 7.1 percent, the Labor Department reported. Food prices increased 1.4 percent after falling for five straight months. Excluding the volatile energy and food categories, the core rate of the producer price index rose 0.3 percent.

Compared with September 2004, prices rose 6.9 percent over all and 2.6 percent excluding food and energy.

The latest report follows data released last week showing that consumer prices last month rose 1.2 percent over all and 0.1 percent excluding food and energy. Unlike producer prices, consumer prices include taxes, subsidies and distribution costs.

Economists were expecting a far smaller jump in producer prices - 1.2 percent over all and 0.2 percent excluding food and energy.

Prices rose even faster for raw materials (up 10.2 percent) and goods that are in intermediate stages of production (up 2.5 percent) than they did for finished goods.

So here's the problem for the economy: higher gasoline prices affect consumers by shifting their purchase decisions away from other items to compensate for higher day-to-day fuel costs. This causes a problem for producers who ordinarily when faced with higher production costs would pass those on to the consumer. But with consumers already nervous and cutting back on other purchases higher costs would simply cause them to further shy away from additional purchases. The result is that, at least for the time being, many producers are forced to eat the difference with short-term results of of decreased earnings and lower stock performance.

In the medium term (9-16 months say) look for the traditional recession-causing feedback loop to begin to rear its head whereby those lower profits and share prices begin to affect the other areas of the economy in the usual ways; through decreased investment, growing unemployment and so on. The big problem with any resultant recession is that we will be forced you to outside of the traditional fuel use channels. In other words, until we change our fuel use patterns, e.g. drive less, more efficient vehicles, move away from trucks and to rail for transport, we are going to have a difficult time recovering from a recession with one of the key components being oil/natural gas price and/or scarcity. And of course the doubleplus huge problem with a future recession is that the Fed will largely have its hands tied in its ability to use interest rates to prime the economic pump because of our national debt situation. But that's another post for another day.