Fuel prices' toll on U.S. economy

Obviously, the sharp rise in the price of oil – $80 a barrel higher than a year ago – has major, negative consequences for the economy.

Every time the local gas station raises the price at the pump, consumers' wallets are getting pinched – something that could affect impulse purchases this summer, such as for ice cream or jewelry. At the same time, businesses are trying to pass on their higher costs for everything from PVC tubing to steel bars. Such changes may go beyond the short term: Some Americans are now making lifestyle changes, most of them involving belt-tightening.

Economists are divided, however, over whether the price of oil has skyrocketed enough to push the economy into a recession. The optimists see Americans making adjustments, scrimping when they can to make up for the extra cost of gasoline.

"The economy is still growing," says Richard DeKaser, chief economist of National City Corp. in Cleveland. "There is nothing magical about $130 [a barrel] oil. It's just more of a drag, more intense."

The pessimists say that the rise in energy prices is coming too fast and that the US economy is now in an "oil shock" downturn.

"For the average American, we are in a recession," says Mark Zandi, chief economist for Moody's Economy.com. "They are worth less than last year; their purchasing power has evaporated; they are past the breaking point."

Every $10 increase in the price of a barrel of oil lowers America's output of goods and services (known as the gross domestic product) by about 0.2 percent, economists calculate. This means that the economy has lost 1.6 percent in the past year due to the rise in oil prices. Since January, oil prices are up nearly $40 a barrel, or 0.8 of the GDP. The fiscal stimulus package passed by Congress was intended to add about 1 percent to GDP.

"We have been struggling against a severe headwind, and the latest developments suggest the headwind is increasing," Mr. DeKaser says.

Consumers notice rising energy costs the most when they fill up the family car. Since Jan. 1, gasoline prices are up 89 cents a gallon, according to GasPriceWatch.com. "Every penny increase in a gallon of gasoline costs American consumers [collectively] just over $1 billion over the subsequent year," Mr. Zandi calculates.

In surveys, the Gallup Organization has found different gasoline prices that were "tipping" points for consumers. The first one was $3 a gallon (the United States hit that about Jan. 1). The next one is $4 a gallon, which is only 8 cents above last Friday's price, according to GasPriceWatch.com.

"The degree at which they adjust their lives increases as we hit those prices," says Dennis Jacobe, chief economist at Gallup in Washington. "For example, shopping behavior changes considerably. There is less impulse buying, and people don't go out as much for weekend activity."

As the price of energy rises, the first thing people try to do is maintain their standard of living, Gallup has found. "They sacrifice saving," Mr. Jacobe says. "But when it comes to major impacts like $4- or $5-per-gallon gas, people start to change their lifestyle. We are starting to see it where people are parking their big vehicles and driving something more fuel efficient."

Ford Motor Co. has already noticed this shift. Last Thursday, it said it would cut production of some larger vehicles by as much as 40 percent in the second half of 2008.

The business sector, which generally has become a more efficient energy user, is making other changes, too. Kenneth Simonson, chief economist at the Associated General Contractors of America, is seeing more price increases and fuel surcharges.

Construction companies are getting squeezed by more than energy prices. Steel prices have been rising, up 5.5 percent in both March and April over the previous months' levels. Among the reasons: strong foreign demand and the weak dollar, as well as the rise in energy prices, Mr. Simonson says.

But prices are also starting to ratchet up for plastic products, he says, because natural-gas prices have been rising as well. He cites one contractor who wrote him that he had just been told his costs for PVC (polyvinyl chloride) products were going up 20 to 30 percent.

Simonson finds anecdotal evidence that some of these cost increases are getting pushed through to consumers. He points to a Holyoke, Mass., roofing contractor who is raising prices 5 to 8 percent on some plastic products.

One result of the rising prices, combined with slowing demand and higher financing costs, is that an increasing number of projects are getting deferred, he says.

The economy could probably cope with just the energy price increases, says Don Norman, an economist at the Manufacturers Alliance/MAPI in Arlington, Va. But he notes that energy costs are rising against a backdrop of falling home prices and the collapse of the subprime mortgage market – which have affected the ability of all sorts of businesses to get loans. "It's a triple whammy. It's amazing the economy has been as resilient as it has been, given all the hits it has taken," Mr. Norman says.

Consumers have yet to feel the full impact of the rising price of oil. Norman estimates it will take another four to six weeks for that to happen. Given the current price of oil, Zandi estimates that gasoline should be closer to $4.50 a gallon. A sharp rise like this could cause the economy yet more problems.

"When people see high gas prices and then see it rising several cents a gallon each day, that is when they have the psychological problem of not knowing how high it will go," Jacobe says. "When that happens, people start to adjust their lifestyle."