Arnold Kling  

Economic Impact of the Hurricane

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Grey-area Medicine and Non-mon... Dear Prudence...

The first place I went for an economic assessment of the impact of Hurricane Katrina was James Hamilton's www.econbrowser.com, because of his expertise in energy. I was not disappointed. For example, he wrote,


One of the questions I am almost always asked by reporters is, "will the price Americans pay at the pump go even higher?" My stock answer is, "I'm not sure." But in the present circumstances, having just seen a 55 cent per gallon rise in the price of September gasoline futures, the question is a no-brainer-- American consumers are in for a huge shock at the pump within a very short period.

And the next question I get asked is, "will that put the U.S. into a recession?" If it were just the consequences of the storm itself, my answer would have been, "probably not." The reason is that I think most people would see this as a special event, tragic but thankfully short-lived. But this event did not arrive out of the blue. Instead, it came in an environment in which there was already considerable anxiety about gas prices and sound basis for worrying about a possible recession even if Katrina had done no harm.

Could this be enough to tip the whole economic cart over? I'm not certain that it will. But it would seem foolish to deny the very real possibility that it could.


I think that he has mis-spoken a bit here. Suppose that the hurricane reduces our annualized economic growth rate by three percentage points over three quarters. Suppose that this drops growth from a without-the-storm baseline of two percent to negative one percent. Then it will have caused a recession, to be sure. But the phrase "tip the whole economic cart over" is a bit strong, in my view.

I am rooting for very high gasoline prices--$5 or $6 a gallon. I believe that is what it will take to cause people to sharply curtail unnecessary use, which in turns is what will be needed to cope with the loss of refinery capacity. Once the infrastructure is rebuilt, then gas prices can and will come back down.

This is not the start of a long-term energy crisis. However, oil production capacity in the Gulf has been reduced, at least for a while. But the near-term issue, as James points out, is the loss of refining capacity. The price of crude oil may or may not spike, but the prices of refined products will certainly spike.


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COMMENTS (12 to date)
Paul N writes:

I think that "rooting" for $5 gas is inappropriate; it's a lot like rooting for Katrina to be as destructive as possible (or at least like rooting for inflation).

Furthermore, I don't believe there's any evidence or theory that would suggest that gas will subsequently move to lower prices if it first reaches $5 than if it doesn't.

Danno writes:

If you're rooting for $5 dollar gas, can you pay for the driving I'm going to have to do in the next few weeks?

Bob writes:

Paul,

If refining capacity falls, gas consumption will have to fall. Arnold simply prefers rationing by market price rather than by market shortage. As it should be unless you want ambulances running out of gas because Congress decreed prices cannot go above $3/gal.

Bob Knaus writes:

Consumers hate high gas prices but there is plenty of evidence to show that higher prices, even over a relatively short period, will result in long-term reduction of energy demand.

Consider what my family did during the oil shocks of the '70s when it looked like energy prices had nowhere to go but up. My dad insulated the roof, installed a solar water heater, and bought diesel vehicles. Some of these investments were not so sound, but they did cut back on our household energy use.

More importantly, we significantly altered our farming practices:

When agricultural plastic ground covers first came out, all the farmers towed big propane tanks behind their tractors to burn the plastic off at the end of the season. Boy did that get expensive! So my dad & uncle developed machinery to remove the plastic mechanically.

Our biggest fuel bill came from the gas-guzzling pumps (hemi-head 454's and such) for our overhead irrigation system. So we switched to drip irrigation, where a 7hp diesel could water the same size field as that Chrysler big-block V8.

Instead of tilling the pathways between vegetable beds for weed control, we switched to using herbicides. At first the highly toxic Paraquat, later the far more effective and benign Roundup. Saved lots of time and gas since we no longer had to drive the tractor down the rows every week or two.

All of these changes reduced energy demand, which was why we did them. As it turned out, they saved time and made our farming more environmentally sound as well. These were long-term changes, my relatives are still farming this way and did not go back to the wasteful methods of 30 years ago.

There is no reason to think that high energy prices will not have a similar effect this time around.

aaron writes:

As people get used to higher gas prices, perhaps this will allow us to add a large gas tax once prices return to normal. Then we could give all commercial users a refund on the tax and only tax the consumer.

spencer writes:

Maybe the thing we need to watch for is the impact of high gas on consumer incomes and confidence going into X-mas. Retailers have already ordered supplies based on an assumption of a good X-mas and they are arriving arriving at the West Coast ports. But what if all this bad news and higher prices cause consumers to pull back and we have a very disappointing X-mas and retailers are left with very large inventories.

In my models recessions happen when the business community makes a mistake -- that is why the consensus never forecast a recession, only a slowdown and it is almost impossible for large econometric model to generate a recession.

Interestingly, if you look at the post WW-II record severe recessions include a bad X-mas and weak recession do not include a bad X-mas.

T.R. Elliott writes:

I agree that gas prices must rise to reduce demand. The pricing mechanism--though painful to those at the lower end of the socioeconomic spectrum, is the only rational way to distribute a resource. This does not imply that society should not have a social net, but the net should not be in the form of gasoline price manipulation.

That said, the temporal terms "Once," "at least for a while," "near-term," are all what can be referred to as weasel words. They are largely meaningless and make it conveninent to make an argument that is similarly meaningless.

Liberatarian/conservative ideologues like to argue that refining capacity is the problem. Yeah, refining is a problem. But that focus ignores the lack of production excess in the world.

Robert writes:


As people get used to higher gas prices, perhaps this will allow us to add a large gas tax once prices return to normal. Then we could give all commercial users a refund on the tax and only tax the consumer.

What is the rationale for this? Is transporting goods from wholesalers to retailers in need of subsidies, when transporting goods from retailers to consumers is not?

beloml writes:

Great! So you're saying that when gas prices go up, my mandatory commute will get correspondingly shorter?

eddie writes:
Great! So you're saying that when gas prices go up, my mandatory commute will get correspondingly shorter?

Nope, it won't; you're probably just screwed. But price increases will change the behavior of the marginal gasoline consumer. It may be that most people have inelastic demand like you, but there are probably enough people whose demand is sufficiently elastic that a price increase will reduce their use. That means that you'll pay more for your mandatory commute, but at least you'll have enough gas to make the commute at all. Without the reduction of use by the marginal consumer, you might find yourself staying home every few days when your limited ration runs out.

Paul N writes:

I'm troubled first by Kling assigning the use of a natural resource as "unnecessary". I'm troubled second by the implication that unstable prices can somehow be more efficient than stable ones. It's especially disappointing coming from economists whom I usually respect.

Lyn writes:

Don't forget that those higher prices echo all through the economy - police cars, school busses, public transportation. Some of those budgets are going to need to be increased to maintain the current level of services - and so will taxes (local/state). That will put additional pressure on consumers' budgets.
As a state worker, I have just been told to cut back/eliminate unnecessary travel, substituting phones and email where possible. (not good news for the airlines, either!). However, since I vividly remember the gas lines of the 70's I am definitely in favor of higher gas prices as a regulatory mechanism.
One problem is that real changes in behavior are expensive (buy a new fuel efficient car) or time-consuming (get a new job nearer home) or both (sell your house and buy new one nearer job). It will take time for people to adjust - and if they don't believe this problem is permanent it won't happen. Why are people still buying SUV's?

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