TJP

Lower Energy Prices: An Instantaneous Stimulus

By Byron A. Ellis-November 12, 2008

Some pundits and politicians believe that additional fiscal stimulus is needed. However, if history is a guide, additional fiscal stimulus might not be the appropriate policy, particularly given the existing stimulus resulting from lower energy prices. Today, the price of gasoline is below $2 dollars in many regions, as opposed to its peak above $4 dollars.

Thus, consumers that drive to work save more that $20 dollars per fill up. The average suburban driver fills up at least 2 times per week. If the average savings per fill up is $20 dollars, savings per week is $40 dollars, per year it is approximately $2,000 per vehicle. In 2006, about 251 million vehicles (BTS) were on U.S roads. Assuming that the $40 dollars savings is applicable to all vehicles, including sport utilities and rigs, the total yearly stimulus per year from lower fuel prices would be more than $500 billion dollars.

Therefore, it is important for the new administration to consider the stimulus due to lower energy prices; and, that it is instantaneously funneled into the economy.

The Kennedy and Johnson administration successfully stimulated the economy, but their success came at a cost of higher inflation that led to a subsequent recession during the Nixon administration. Therefore, the Obama administration must be mindful of over stimulating the economy.

Additionally, the new administration must understand that high-energy prices had a significant impact on the current economic slowdown. A review of professor James D. Hamilton’s research on oil and macroeconomics would be helpful to understand the adverse consequences on the U.S. and world economies caused by upward spikes in oil prices.

Expansionary fiscal policies tend to produce inflation, unless they occur in periods of protracted low aggregate demand. High inflation leads to high interest rates, economic slowdown and unemployment.

Thus, it is important for the new administration to also consider monetary policies for increasing aggregate demand and employment. Low interest rates and increases in the quantity of money tent to stimulate investment, which increases aggregate demand and employment

As noted by Milton Friedman, many economists believed that monetary policy is a string; it can be pulled to stop inflation, but cannot be pushed to halt recession. Therefore, the general belief is that fiscal policy, in the form of government spending, can make up for insufficient private investment.

Notwithstanding that belief, it is important for the new administration to assess the rate of growth of the quantity of money, because, if the quantity of money is appropriately increased, the economy will expand. Through monetary policies, the Federal Reserve is able to manipulate the quantity of money to affect interest rates and income.

Friedman noted that the Great Contraction was a testimony to the power of money; the Federal Reserve failed to exercise the responsibilities assigned to it in the Federal Reserve Act to oversee the U.S. financial system and to provide liquidity to the banking system. For instance, when the Federal Reserve executes an open market purchase, it increases the nominal and real quantity of money, as a consequence the money market equilibrium schedule shift downwards, causing interest rates to decrease and gross domestic product to increase.

Friedman also noted that fiscal policies respond sluggishly and with long logs and even when emphasis was shifted to taxes, political factors prevented prompt adjustments. For instance, given the appropriate quantity of money mortgage interest rates would be more favorable and many homeowners could restructure high mortgage interest rates.

The Obama administration should quickly take the reins of the Treasury away form Paulson and Kashkari, as well as reins of the Federal Reserve from Bernanke and replace them with individuals that are more supportive of the Middle America.

For a speedy economic recovery, it is paramount to buttress homeowners, which the current Treasury and the Federal Reserve leadership have not been capable of doing. Secondly, crude oil being the lifeblood of modern economies should not be prone to speculator pricing.

Thus, the new administration must quickly and expeditiously implement personnel and policy changes at the Commodity Futures Trading Commission (CFTC). The CFTC is the government agency responsible for overseeing the trading of futures for oil, precious metals, grains, currencies and the like; as well as, trading in derivatives linked to stock indexes and bonds. Some, in Congress and elsewhere, have argued that the agency failed to prevent crude oil speculation.

We now know that trading in credit default swaps (CDS), an unregulated financial insurance whereby the buyer makes periodic payments to the seller in exchange for the right to a payoff if there is a default or credit event in respect of a third party or reference entity had a more adverse effect on the economy than sub prime mortgages. Furthermore, that Goldman Sachs Group Inc., JPMorgan Chase & Co., and other dealers created and controlled trading in the credit-default swap market.

Therefore, having former Goldman Sachs personnel, Paulson and Kashkari in charged of the $700 billion taxpayer bailout is a real conflict of interest.                  

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