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|  | MARCH 14, 2005
 DAVID WYSS ON THE ECONOMY By David Wyss Oil's Rise Isn't the Economy's Fall Energy prices would have to go a lot higher before pushing the U.S. toward recession, thanks to a series of changes since the last oil shocks After dropping back near $40 a barrel, oil prices have pushed higher again -- challenging the $55 high hit last October. Despite the pressure of costlier oil, the economy seems to be running on all cylinders, and fears that it will freeze up over energy costs are exaggerated. Higher oil prices are damaging consumer spending less than we at Standard & Poor's had expected. Although gasoline prices are nearing $2 a gallon, car sales have held up, and there seems only a slight tendency to buy more fuel-efficient vehicles. Consumers also aren't letting their fuel bills stop them from buying other goods. NO BIGGIE? Energy just isn't as important to the economy as it was in the last major price surge during the early 1980s. In 1981, it was 14% of GDP, compared to 7% today. Consumer energy purchases were more than 8% of disposable income, vs. 5% today. The lowered importance doesn't mean prices can't cause a recession, but they have to go higher still for that to happen. Even corrected for inflation, oil prices are well below the peak they hit in 1981. Nominal oil prices reached $35 a barrel, but in today's dollars that translates to $76 (using the overall CPI). Gasoline prices have gone up less in percentage terms than oil, because refinery margins are proportionately lower today, and taxes have been stable. Cars have, on average, become more fuel-efficient. The average light vehicle on the road in 1981 got 14.3 miles per gallon. Today's gets 19.8. Interestingly, the average new car gets 21.1 mpg, about the same as in 1981, but the extremely fuel-inefficient cars from the 1970s are now largely off the road. IT'S ABOUT QUALITY. The combination of more fuel-efficient and costlier cars, plus higher insurance rates, means gasoline is a smaller part of the average American's auto transportation bill than it was 20 years ago. The real price of a new car has risen 22.7% since the mid-1980s, despite the fact the price index for new cars has dropped relative to the CPI. The difference reflects the change in quality. Americans now insist that their cars be bigger, have better acceleration, higher safety standards, fancier seats, and more speakers (forbid that we might actually have to wind down a window manually). Even at $2 a gallon, the average car driven 12,000 miles per year will only use $1,200 (600 gallons) of gasoline. That's less than half the depreciation and interest cost of the average new car over that period, and lower than most insurance bills (especially in New York). A 50-cent rise in gasoline prices increases annual operating costs only 0.5% of the average household's income. The fundamental reason for the drop in energy as a share of income is that energy usage per capita has been virtually flat for the last 25 years, while household incomes have doubled. CLOSER TO PAR. At S&P, we still expect oil prices to drop into the $35 range over the next two years, but we wouldn't be surprised if prices go up instead. Still, unless oil hits new highs, the impact on the economy will be limited. There's little sign of domestic inflation, a surprise given the sharp rise in oil and other commodity prices. The last two major oil price spikes in 1974 and 1979 were followed by periods of extreme inflation. The core CPI is now up 2.3% from a year ago (January), double the 1.1% of December, 2003. The current rate is more acceptable to the Fed than 1.1%, which created (overblown) worries about deflation. The central bank would like to hold the number near 2%, however, and doesn't want it edging any higher. Including food and energy, consumer prices are up 3%, still a rather moderate rate. Higher oil and commodity prices do suggest inflation will increase in the near future –- certainly the headline rate and probably also the core rate. But commodity prices, especially energy, aren't as important for the economy as they used to be.  Wyss is chief economist for Standard & Poor's Edited by Patricia O'Connell All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is or will be, directly or indirectly related to the specific recommendations or views expressed in this research report. Standard & Poor's Regulatory Disclosure Any advice, analysis, or recommendations contained in articles labeled "Insight from Standard & Poor's" reflect the views of Standard & Poor's, which operates separately from and independently of BusinessWeek Online. It is possible that BWOL may from time to time publish information that is not consistent with advice, analysis, or recommendations that are published by Standard & Poor's. Standard & Poor's and BusinessWeek Online are each units of The McGraw-Hill Companies, Inc.
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