The U.S. Economy Isn’t Immune to Rising Oil Prices

How sensitive is the U.S. economy to rising oil prices? A popular view is that growing U.S. energy output has largely immunized the economy against the adverse effects of pricier oil. As evidence of this decrease in sensitivity, many point to the 2014–2016 experience, when a collapse in oil prices did not lead to the expected material rebound in economic activity.

While we agree that the U.S. economy’s overall sensitivity to oil prices has evolved, in large part due to a rapidly shrinking energy trade balance, we caution against extrapolating too much from the 2014 experience. In the near term, diminished pipeline capacity and other bottlenecks will likely curb the acceleration in investment growth that would otherwise accompany higher oil prices.

As a result, we expect the recent rise in oil prices to be a modest headwind to U.S. economic activity while supporting inflation.

The late-2014 oil plunge: Past may not be prologue

OPEC’s November 2014 decision to maintain output despite already elevated global production and inventories triggered a slide in global crude oil prices of nearly 75% through early 2016. Historical patterns would indicate that such a drop in oil prices should have boosted overall economic activity in the U.S. – a net oil importer – by increasing households’ real purchasing power and boosting corporate profits. Yet U.S. economic growth rates were actually lower during this period.

One of the principal drivers of the atypical economic response was the collapse in U.S. energy investment and the knock-on effects on other upstream industries, which together greatly reduced the net economic benefits of cheaper oil. For instance, U.S. natural gas and oil-directed rig counts fell by 80% between the end of 2014 and early 2016, subtracting nearly 0.5 percentage point from U.S. real GDP growth.

However, with oil prices now rising again, we caution against inferring too much from the 2014–2016 experience. While the decline in the U.S. oil trade deficit over the past five to 10 years may ease the economic headwinds, some key factors will likely constrain the potential positive economic impulse from higher energy investment: