How have changing oil prices impacted US and global economic prospects? originally appeared on Quora - the knowledge sharing network where compelling questions are answered by people with unique insights.
There is still a lot of confusion on this one, so let's be clear: when oil prices fall because oil supply goes up, this is good for the global economy. And that is what happened this time around. It is a transfer of resources from oil exporting countries to oil importers. And oil importers tend to spend more of it, whereas oil exporters tend to save more--so there is a positive impact on global growth. Oil importers - countries like India - get cheaper energy. Their consumers have more money to spend, and governments more resources to invest. Also, oil importers tend to have more diversified economies with broader manufacturing sectors and more innovation--so this shift of resources goes to finance higher quality growth.
Financial markets these days have it backwards: if oil prices fall, stock markets drop. If oil prices rise, stocks go up. Investors seem to interpret lower oil prices as a sign of recession, reducing demand. But we know from the data that the world economy is not in recession, and oil demand has kept increasing. It's just that supply has gone up more, in large part because of greater US supply. So the only negative impact on equities is through stocks of energy companies, which of course get squeezed on their margins and need to adjust. But the impact on global growth is positive, and that is good for every other industry.
The stress on US energy companies explains why the positive impact on US growth has not been as big as was hoped. Again let's be clear, on net lower oil prices have been good for the US economy. They have acted like a big tax cut for consumers, and household consumption has been the main engine of US growth. But there has been a big decline in energy investment in the US, and that has offset some of the gains. Some--not all.
The IMF recently argued that lower oil prices can be bad for growth because they cause deflation, and therefore increase real interest rates (nominal interest rates minus inflation). This makes no sense to me. Deflation is a problem when it gets entrenched, when prices keep falling and people expect them to keep falling. But there is no deflation. US headline inflation has quickly rebounded as soon as energy prices have stabilized (they could not keep falling forever).
So low oil prices are good for the US economy and the global economy. When you hear otherwise, you have stepped through the looking glass and ended up in nonsense land, as I argued in a recent blog.