Mixed signals leave economists uncertain

Analysis

April 25, 2006|By PAUL ADAMS | PAUL ADAMS,SUN REPORTER

When oil topped $35 a barrel for the first time just before the Iraq war, economists were sure the nation was in for soaring gas prices and a likely economic downturn.

Now that oil costs more than twice that much, economists are just as nervous, and twice as confused.

Instead of a recession, last fall's record rise in gas prices was followed by a quarter of spectacular U.S. economic growth, moderate inflation and unexpectedly strong job gains.

That raises the question: Can the U.S. economy sustain $3-per-gallon gas indefinitely? What about $4, as is already the case in Beverly Hills, Calif.? Or even $5 a gallon?

With gas prices again heading for record territory, many economists are optimistic that the economy will continue to grow - though at a much slower pace - thanks to increased worker productivity and energy efficiencies gained from years of corporate investment in technology.

"We thought [last fall] that $70 oil would take the economy down to a recession, and that hasn't happened," said Steve Cochrane, a senior economist for Economy.com in West Chester, Pa. "Part of it is that the economy has changed so much in the past 20 years in ways that we've only really begun to understand."

Consumers show signs that they are willing to maintain an exuberant pace of spending despite much grumbling at filling stations, where the average price for regular unleaded yesterday topped $2.94 in Baltimore and $2.90 nationally, according to AAA.

Most analysts agree that the nation's economy is far more flexible than it was a generation ago, and it takes about half as much energy to produce the same level of economic output as it did 30 years ago. So, the theory goes, maybe fuel prices just don't matter nearly as much as they used to.

There are signs of strain, however. Consumer prices rose sharply in March, with economists pinning the blame at least in part on rising fuel costs. But even core inflation - which excludes energy and food - zipped along at its fastest pace in a year, the government reported last week.

The mixed signals have economists conflicted about what the country will look like if gasoline prices continue on their upward trajectory.

Here's what some experts say:

At $3 a gallon

It's unlikely that many consumers will turn in their SUVs and trade their homes in distant suburbs for new ones closer in. But with gas prices taking more of a bite out of household budgets and core inflation rising faster than wage growth, consumers - whose spending accounts for two-thirds of the economy - might be forced to cut back.

It's basic arithmetic, economists say. A year ago, prices were rising at about 3.4 percent, which was pretty close to average wage growth, so consumers could handle the increases without cutting back significantly. But this year, inflation is up around 4.3 percent, which means that household budgets could start to fall behind if the trend continues.

"There's no question there's going to be pretty significant impacts in terms of standard of living," said Brian Bethune, an economist at Global Insight in Lexington, Mass.

Most economists think the recent surge in oil and gas prices will cut economic growth roughly in half, from 5 percent in the first three months of this year to about 2 percent to 2.5 percent in the second half of the year. That will mean significantly slower job growth, which may push unemployment.

Such growth would still be far from recessionary, economists said. But the effects could start to show in everything from the price of a loaf of bread to a new washing machine.

Until now, businesses have offset rising fuel costs by investing in technology that helps them wring more productivity out of every worker. Those gains are beginning to fade as fuel prices continue to rise.

"We're running out of wiggle room that businesses had to absorb higher costs," said Joel Naroff, president of Naroff Economic Advisers. "That means they need to raise prices."

The price of chemicals used by many manufacturers is up 9 percent over the cost a year ago, said David Huether, chief economist for the National Association of Manufacturers. Metals are up, and machinery costs are climbing, too. During past energy spikes, manufacturers absorbed those costs, believing the increases were temporary. But those hopes are fading.

The price of a vacation is already going up, whether by car or by air. Airlines are raising ticket prices to stave off further losses. Jet fuel has historically been the second-highest airline cost, next to labor. But fuel has taken over the top spot for several major carriers. Industry experts project that the industry will spend $2.5 billion more for fuel this year, assuming no further increases.

"The pricing power [of airlines] has been improving, but it's not at a fast enough clip to offset higher fuel prices," said John Heimlich, an economist for the Air Transport Association, a trade group.

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