Moreover, if we account for the economic multiplier, lower gasoline prices would contribute over $1.4 trillion dollars to the U.S. economy. This figure is obtained e by assuming a marginal propensity to consume of 0.80 and a tax rate of 0.20, then the multiplier {1/[1 – 0.80(1 – 0.20)} is 2.78. So, lower gasoline prices would add {$522 billion X 2.78 = $1.4 trillion dollars}.

We’re also seeing signs of lower food prices, which will create additional consumer savings and, fuel surcharges should also diminish or become non-existent over time.

The effect over time is to return the economy to the pre-invasion of Iraq level.

Therefore, it is important for the new administration to establish processes that will prevent Middle East instability, as well as the resulting speculation in the crude oil futures markets.

In times of instability, traders should not be able to purchase more oil on the commodity futures market than actually exist in transit and in storage.

Purchasing more oil than actually exist creates an artificial demand and given a fixed supply, the result is artificially high prices. The commodity market demand for crude oil is seldom the real demand, since many of the future crude oil purchases are not physically delivered.

Some economists argue that speculators stabilize markets. However, how can crude oil speculators stabilize the market by destabilizing the economy?

Moreover, it is clear from history that spikes in crude oil prices preceded the vast majority of economic contractions since World War II.

Thus, unscrupulous traders should not be allowed to manipulate crude oil prices; crude oil is the lifeblood of the world economy.

The damaged induced by high crude oil prices is clear, if lower crude oil prices will add through the multiplier effect more than $1.4 trillion dollars to the U.S. national income. Higher crude oil prices caused national income to contract by the same amount.

As we have argued before, higher energy prices adversely affected the budgets of U.S. consumers. U.S. consumers had to reallocate outlays from housing, food, entertainment, and other commodities and services to compensate for higher energy prices.

As a result, marginal consumers were not able to pay their mortgages. And, as mortgage defaults increased, it affected the bets made using credit default swap (CDS) where banks and hedge funds allowed individuals without securities to buy insurance against securities that they did not own.

A CDS is, basically, 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.

Thus, the root cause of the current economic contraction is the spike in crude oil prices due to Middle East instability. Therefore, lower crude oil prices will increase consumer spending on items other than energy and provide a needed stimulus to the economy.

Any additional stimulus from the new administration should be targeted and relative small, and limited to the promised middle class tax cuts and public spending on crumbling infrastructure.

With lower oil prices, the economy will begin to expand. However, if the new administration over stimulated the economy, the result would be inflation, higher interest rates, and another contraction.

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