When I first began working on my Ph.D. dissertation in 1980, I was intrigued by the fact that the oil embargo of 1973-74 and the collapse in Iranian oil production after the revolution in 1978 were both followed by global recessions. But when I called attention to the fact there had been a sharp increase in the price of oil prior to 6 of the 7 postwar U.S. recessions up to that point, the general response was one of skepticism.

By the time I was presenting evidence of this relation at various seminars in 1981-82, the Iran-Iraq War had produced yet another shock to world oil markets and the NBER declared that the U.S. experienced a new recession immediately on the heels of the previous downturn, meaning that the evidence had now become that 7 out of 8 recessions had followed oil price increases. That research was subsequently published in the Journal of Political Economy in 1983 and the Energy Journal in 1985. My ideas about how this relationship might be explained by disruptive changes in the composition of spending appeared in the Journal of Political Economy in 1988.

We received some more evidence on this relationship when Saddam Hussein invaded Kuwait in August 1990, causing oil prices once again to double and coinciding with the 9th postwar recession. The price of oil also shot up before the 2001 recession. Add in the conjunction of the oil shock of 2007-08 with our current economic pickle, and my count is now up to 10 out of 11.

For the record, my position has never been that oil prices were the sole cause of all of these recessions. But the evidence persuaded me that oil must have been a contributing factor in at least some postwar recessions.

Given my long interest in this area, the Brookings Institution approached me about the possibility of writing a paper on the causes and consequences of the oil shock of 2007-08. In that paper I compared what happened last year with what we'd seen in the many previous episodes. I presented those findings at a Brookings conference earlier this month, and described some of the results for Econbrowser readers here and here.

One of the things I did in that paper was to examine a number of different models of the effects of oil prices on the economy that had been developed for earlier data, and look at what those models would have predicted to happen in 2007-08. My conclusion was that most of those models held up pretty well. Using any of the estimates surveyed, the oil shock of 2007-08 was big enough to have made a material negative contribution to real GDP over the period 2007:Q4 to 2008:Q3, and the details of what happened over that period are quite consistent with the predictions.

The reason that I think this is an interesting finding is that this period-- 2007:Q4 to 2008:Q3-- was when the U.S. entered recession #11. The fourth quarter of 2008 saw a very dramatic deterioration in all the economic indicators, but if you focus just on the first 12 months of the recession-- 2007:Q4 to 2008:Q3-- things wouldn't have had to be much better before most analysts would have said that the economy was not even in a recession prior to 2008:Q4. For example, real GDP actually grew by 0.7% between 2007:Q3 and 2008:Q3.

Dave Cohen argues that the GDP figures are too optimistic, and I agree. But whatever your preferred measure might be, it wouldn't take much to nudge 2007:Q4-2008:Q3 into a range that's not usually associated with recessions. For example, gross domestic income on average fell by -0.45% over 2007:Q4-2008:Q3. My paper calculated that using any of the models surveyed this would have been a positive number if there had not been the contractionary effects of the oil shock. Alternatively, a 12-month drop in total employment is sometimes used as another indicator of whether the economy is in a recession. We crossed that threshold in the summer of 2008. But if we had not shed 150,000 jobs in auto manufacturing-- job losses that I think were pretty clearly tied directly to the oil price shock-- employment growth would still have been positive going into the fall of 2008.

Comparison of the effects on auto industry employment of the oil shocks of 1990 and 2007-08. Graph shows cumulative change in the number of workers employed in motor vehicles and parts manufacturing in months subsequent to July 1990 (red) and July 2007 (blue).

Why does it matter whether, in the absence of the oil shock, the experience over 2007:Q4-2008:Q3 might have been a bit better in terms of such measures as GDP or employment? My answer is that the drops in overall spending that were caused by higher oil prices proved to be the knockout punch for an economy that was already wobbly. Whatever your preferred culprit might be for our current difficulties-- loan default rates, falling house prices, debt burdens, or pessimistic sentiment-- that measure would have had a more favorable value going into the fall of 2008 if we had experienced more favorable fundamentals in terms of income and jobs over 2007:Q4-2008:Q3. And there's no question that more favorable fundamentals are exactly what we would have had if the price of oil had never gone over $100 a barrel.

The fact that the biggest drop in output didn't occur until well after the oil price went up, and resulted not from the oil price itself but instead from the interaction with other factors and the dynamic forces unleashed when the overall level of economic activity began to decline, is also exactly the same pattern we saw in each of the previous recessions.

Was the oil shock of 2007-08 the sole cause of the recession? Certainly not. But did it make a material contribution? In my opinion, the answer unquestionably is yes.

You can also find a lot more discussion over at theoildrum.com ([1], [2], [3]).

Technorati Tags: oil, oil prices, oil shocks

My paper uses a number of different models that had been fit to earlier historical episodes to see what they imply about the contribution that the oil shock of 2007-08 might have made to real GDP growth over the last year. The approaches surveyed include Edelstein and Kilian (2007), who examined the detailed response of various components of consumer spending, Blanchard and Gali (2007), who studied the extent to which the contribution of oil shocks has significantly decreased over time, my 2003 paper, which emphasized the role of nonlinearities, and a model-free data summary of the observed behavior of different economic magnitudes following this and previous oil shocks. Although the approaches are quite different, they all support a common conclusion: had there been no increase in oil prices between 2007:Q3 and 2008:Q2, the U.S. economy would not have been in a recession over the period 2007:Q4 through 2008:Q3.

One of the most interesting calculations for me was to look at the implications of my 2003 model. I used those historically estimated parameters to find the answer to the following conditional forecasting equation. Suppose you knew in 2007:Q3 what GDP had been doing up through that date and could know in advance what was about to happen to the price of oil. What path would you have then predicted the economy to follow for 2007:Q4 through 2008:Q4?

The answer is given in the diagram below. The green dotted line is the forecast if we ignored the information about oil prices, while the red dashed line is the forecast conditional on the huge run-up in oil prices that subsequently occurred. The black line is the actual observed path for real GDP. Somewhat astonishingly, that model would have predicted the course of GDP over 2008 pretty accurately and would attribute a substantial fraction of the significant drop in 2008:Q4 real GDP to the oil price increases.

Solid line: 100 times the natural log of real GDP. Dotted line: dynamic forecast (1- to 5-quarters ahead) based on coefficients of univariate AR(4) estimated 1949:Q2 to 2001:Q3 and applied to GDP data through 2007:Q3. Dashed line: dynamic conditional forecast (1- to 5-quarters ahead) based on coefficients reported in equation (3.8) in Hamilton (2003) (which was estimated over 1949:Q2 to 2001:Q3) applied to GDP data through 2007:Q3 and conditioning on the ex-post realizations of the net oil price increase measure.

The implication that almost all of the downturn of 2008 could be attributed to the oil shock is a stronger conclusion than emerged from any of the other models surveyed in my Brookings paper, and is a conclusion that I don't fully believe myself. Unquestionably there were other very important shocks hitting the economy in 2007-08, first among which would be the problems in the housing sector. But housing had already been subtracting 0.94% from the average annual GDP growth rate over 2006:Q4-2007:Q3, when the economy did not appear to be in a recession. And housing subtracted only 0.89% over 2007:Q4-2008:Q3, when we now say that the economy was in recession. Something in addition to housing began to drag the economy down over the later period, and all the calculations in the paper support the conclusion that oil prices were an important factor in turning that slowdown into a recession.

It is interesting also that the observed dynamics over 2007:Q4-2008:Q4 are similar to those associated with earlier oil shocks and recessions. The biggest drops in GDP come significantly after the oil price shock itself. What we saw in earlier episodes was that the drops in spending caused by the oil price increases resulted in lost incomes and jobs in affected sectors, with those losses then magnifying other stresses on the economy and producing a multiplier dynamic that gathered force over subsequent quarters. The mortgage delinquencies and financial turmoil in the current episode are of course not the specific stresses that operated in earlier downturns, but the broad features of that multiplier process are surprisingly similar to the historical pattern.

My paper concludes:

Eventually, the declines in income and house prices set mortgage delinquency rates beyond a threshold at which the overall solvency of the financial system itself came to be questioned, and the modest recession of 2007:Q4-2008:Q3 turned into a ferocious downturn in 2008:Q4. Whether we would have avoided those events had the economy not gone into recession, or instead would have merely postponed them, is a matter of conjecture. Regardless of how we answer that question, the evidence to me is persuasive that, had there been no oil shock, we would have described the U.S. economy in 2007:Q4-2008:Q3 as growing slowly, but not in a recession.

Technorati Tags: oil, oil prices, oil shocks

Edelstein and Kilian summarized the historical correlations between energy prices and economic activity in terms of some basic forecasting equations. They started with a simple model that could be used to predict real personal consumption expenditures on the basis of past consumption spending and past changes in the relative price of energy. Their measure of energy prices was scaled by the share of energy purchases in total spending, so that if their energy-price measure goes up by one unit, it means that a consumer who tried to consume the same amount of energy as before would have to cut total real spending on other goods and services by 1%. In the graph below, I have reproduced their calculation for how their forecast of real consumption expenditures in month t+s would change if an energy price increase reduced disposable income by 1% in month t. This calculation is plotted as a function of s, how many months into the future we're trying to forecast, so that as you move to the right along the graph, you're looking at the consequences farther and farther into the future of an event (an energy price increase) that occurs now.

Impulse-response function (black) and 95% confidence intervals (blue) from bivariate vector autoregression for response of PCE to an energy price increase that reduces disposable income by 1%. Vertical axis: deviation at date t+s of 100 times the natural log of real consumption spending from level that would have been anticipated in the absence of an increase in energy prices at date t. Horizontal axis: time horizon s. Reproduces Figure 8a in Edelstein and Kilian (2007).

The graph shows, not surprisingly, that when energy prices go up, consumer spending falls. But there are two surprising things about the quantitative character of this response. The first surprise is the delay-- energy prices go up at time t, but the biggest consequences for consumption spending aren't seen until s = 12 months later. The second surprising feature of these results is the magnitude. If consumers continued to purchase the same number of gallons of gasoline as they had before, a shock of the size analyzed in this graph would require them to reduce spending on other items by 1%. Yet eventually they historically would be predicted to reduce spending by 2.2%. Why do consumers cut spending by so much more than the shock itself?

Edelstein and Kilian proposed to find some answers to these questions by looking at specific components of consumption spending. The three graphs shown below break spending down into services, nondurables, and durables. The magnitude of the response of the first two categories-- about a 1.5% reduction in spending on services or nondurables-- is more in line with what we might have expected. The real action is in durables. Purchases of items such as appliances and automobiles respond very dramatically to a change in energy prices.

Impulse-response function and 95% confidence intervals from bivariate vector autoregressions for response of (a) 100 times the natural log of real services consumption, (b) 100 times the natural log of real nondurables consumption, and (c) 100 times the natural log of real durables consumption to an energy price increase that reduces disposable income by 1%. Reproduces Figures 8b-d in Edelstein and Kilian (2007).

Looking further at the composition of durable goods, Edelstein and Kilian found that by far the most dramatic response is in terms of spending on motor vehicles and parts. Unlike the other categories of spending, this response is huge and immediate.

Impulse-response function and 95% confidence intervals from bivariate vector autoregressions for response of 100 times the natural log of motor vehicles consumption to an energy price increase that reduces disposable income by 1%. Reproduces Figure 8e in Edelstein and Kilian (2007).

Once we state the basic facts this way, the results seem a lot less mysterious. The response of spending on autos to an energy price increase is not simply a matter of consumers having less disposable income, but instead involves a lot of other factors, such as consumers switching to smaller cars or postponing purchases until they have more confidence about where gasoline prices are going to settle down. As a result of decreased spending, the income of those employed in the auto sector would decline, and for these individuals, their loss in purchasing power is much greater than their personal increase in fuel expenses. As people who derive their income from manufacture and sale of automobiles and parts reduce their spending, the aggregate consequences can accumulate over time, accounting for both the magnitudes and the delays in the response of other categories of consumption spending.

Another interesting finding by Edelstein and Kilian was that consumer sentiment is quite sensitive to energy prices, with a 1% loss in purchasing power quickly translating into a 15% drop in the Reuters/Michigan index of consumer sentiment.

Impulse-response function and 95% confidence intervals from bivariate vector autoregression for response of Reuters/Michigan index of consumer sentiment to an energy price increase that reduces disposable income by 1%. Reproduces Figure 11a in Edelstein and Kilian (2007).

The economics literature is filled with statistical models that seem to do a very good job at fitting the data in hand, but then fall apart when applied to data that arrive after the paper is published. I was curious to see how well the Edelstein-Kilian forecasting equations would have performed over the period since their paper was written. The heart of the system used to generate the graphs above is an equation that predicts a category of consumption spending one month ahead on the basis of the current and past consumption spending and energy prices. I took the parameters as estimated from the historical data set used by Edelstein and Kilian (1970:M1 to 2006:M7), and formed forecasts of each new observation between 2006:M8 and 2008:M9, one month at a time. I then calculated the average squared error of those forecasts. These mean squared forecast errors are reported in the first column of the table below. These are compared in the second column with the errors from a model that forecasts the spending component from its own lagged values alone. For each of the equations used in the graphs above, the Edelstein-Kilian specifications exhibit significant post-sample success.

One can also use these equations to estimate how much of a contribution energy prices made to recent developments. I used the Edelstein-Kilian regressions to form a forecast for the path of real consumption expenditures looking forward from September 2007. That forecast is indicated by the blue line in the graph below, and basically called for consumption spending to continue along the same sort of path we saw earlier in 2007 and 2006. The actual path for spending, indicated by the black line, grew much more sluggishly than this after September 2007 and began to decline in June 2008.

Black: 100 times the natural log of real consumption spending. Blue: path that would have been forecast as of 2007:M9 for 2007:M9 through 2008:M9. Green: path that would have been forecast as of 2007:M9 if one knew the subsequent innovations in energy prices but no other information.

By the nature of this system, one can by definition decompose the gap between the black and blue lines into a series of individual forecast errors, namely the sequence of errors we made trying to predict energy prices one month ahead, and the month-by-month errors we made predicting consumption given those energy prices. One can then use such calculations to ask the following question: What if there had been no surprises with energy prices, and the only errors had been those associated with trying to predict consumption spending conditional on knowing energy prices? [This is an easy calculation to perform using the RATS "history" command]. The result of that "what-if" calculation is plotted as the green line above. The difference between the green line and the blue line could be interpreted as the fraction of the slowdown in consumption spending that one might attribute to energy prices alone. The graph suggests that energy prices played a very significant role in the slowdown in consumption spending.

I performed a similar calculation for spending on motor vehicle and parts, and found that the oil shock made a major contribution to the problems for this sector for 2007:Q4 through 2008:Q2.

Black: 100 times the natural log of real consumption spending on motor vehicles and parts. Blue: path that would have been forecast as of 2007:M9 for 2007:M9 through 2008:M9. Green: path that would have been forecast as of 2007:M9 if one knew the subsequent innovations in energy prices but no other information.

Energy prices were surely also a significant factor in the dramatic deterioration of consumer sentiment in the early part of this year.

Black: index of consumer sentiment. Blue: path that would have been forecast as of 2007:M9 for 2007:M9 through 2008:M9. Green: path that would have been forecast as of 2007:M9 if one knew the subsequent innovations in energy prices but no other information.

My conclusion is that the oil price shock made an important contribution to consumption spending in general and purchases of motor vehicles and parts in particular in the later part of 2007 and first half of 2008. In my next post, I intend to discuss the implications of this for the economy as a whole.

Technorati Tags: oil, oil prices, oil shocks

Americans consumed 142 billion gallons of gasoline last year. That means that when gasoline prices rose $1/gallon last spring, if consumers and fuel-using businesses had not reduced the quantity of gas they purchased, they would have had to reduce other expenditures by $142 billion. That's a bigger negative shock to spending power than the $90 billion that the federal government was trying to put back into consumers' hands through last spring's fiscal stimulus.

The run-up in gasoline prices hurt the economy not just by reducing consumers' spending power. The abrupt drops in spending on key sectors of the economy exerted significant effects of their own. As higher gas prices caused consumers to shun Detroit's gas guzzlers, U.S. production of motor vehicles and parts fell by 15% between 2007:Q4 and 2008:Q3 (BEA Table 1.5.6), subtracting an average of 0.6% from the annual GDP growth rate over the first three quarters of this year (BEA Table 1.5.2). The BLS reports that 135,000 fewer Americans were employed in motor vehicles and parts manufacturing in October 2008 compared with a year ago. And rocketing gasoline prices surely also contributed to plunging consumer confidence over the spring and summer.

Good news, though. The "cavalry has already arrived", according to the WSJ. U.S. national retail gasoline prices are now down $2 a gallon from their height this summer, erasing the -$140 billion drain of last spring and adding net +$140 billion in disposable income for consumers and firms relative to where we stood one year ago.

U.S. average retail gasoline price. Source: NewJerseyGasPrices.com.

But it's hard for me to believe that this is going to replace the negative developments of last spring and summer with a positive stimulus of the opposite sign. Those unemployed auto workers can't expect to report back to work any time soon. And although falling gasoline prices brought a temporary revival to consumer sentiment in September, Americans are now weighed down by other concerns as the economic deterioration sets in. The Michigan/Reuters index of consumer sentiment was back down to 57.6 in October and barely improved to 57.9 in November.

Reuters/Michigan index of consumer sentiment. Data source: FRED and MarketWatch.

Now that we're in our current mess, the whole affair looks to many as if it had an air of inevitability from the beginning. That, however, is not my view. How severe the financial bankruptcies and mortgage defaults ultimately prove to be will depend directly on how far real estate prices decline. The magnitude of the price decline will be bigger the more severe a recession we experience. The economy was continuing to putter along with positive growth despite a dismal housing sector for two years. That by itself wasn't enough to cause a recession. But when you put the depression in housing together with the negative effects of the oil price shock, it proved to be a potent combination.

My view is that we were teetering on the edge of a cliff last summer, and the oil price shock may have been just enough to tip us over the edge. As we did so, the financial disaster that had always been a potential became a reality.

The trouble is, now that the economy is in free fall, it's going to take more than $2 gasoline to pull us back up.

Technorati Tags: macroeconomics, autos, auto+sales, economics, recession, gas prices, oil shock

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The New York Times reports:

Domestic sales declined by 15.5 percent in August compared with the previous year, the fifth consecutive month of double-digit declines, despite some relief in recent weeks on gas prices.

I like to look at these data using graphs like the ones below, to help distinguish seasonal and cyclical factors from trend. (By the way, Econbrowser remains the only site on the web, to my knowledge, where you will find the auto data displayed this way.) You can make year-on-year comparisons by looking across entries within any given set of columns, and see month-to-month changes by looking across groups of columns.

Data source: Wardsauto.com

Sales of light trucks (which includes SUVs) manufactured in North America were clobbered this summer, and August 2008 was down 22% from August 2007. But August domestic truck sales were up 23% compared with July 2008, and you can't describe any significant chunk of that July-to-August improvement as a typical seasonal movement.

Data source: Wardsauto.com

August sales of domestic cars were down 12% year-over-year but up 6.6% month-over-month. The dramatic drop in gasoline prices thus appears to have reversed some of Detroit's hemorrhaging.

U.S. average retail gasoline price. Source: NewJerseyGasPrices.com.

Spencer at Angry Bear is encouraged by the uptick in seasonally adjusted auto sales and wonders if we've passed the bottom. The NYT quotes analysts from GM and Ford as cautiously optimistic.

I am less so. For one thing, even though gasoline prices are lower than they were a month ago, they're still much higher than the last time you bought a car. The swing away from SUVs is in my opinion inexorable, and will continue even if we see, as we may well, significant further declines in oil prices. And there is no way that works to the benefit of the American companies whose market strength has always been in the less fuel-efficient vehicles.

Second, if I'm reading things correctly, the U.S. economic downturn can now be classified as a recession. I don't share the views of those who think we may have seen the bottom there, either. Exports, the key sector that's been keeping GDP growth positive, are significantly threatened by a slowing world economy. And have we turned the corner on the financial mess? If that's how you read the latest developments with Fannie and Freddie, then God bless your cheerful spirit.

I'm expecting job and income losses to continue, and that doesn't bode well for auto sales, no matter what's been happening or may be about to happen to gasoline prices.

Technorati Tags: macroeconomics, autos, auto+sales, gasoline demand, economics, recession, gas prices, oil shock

The dramatic abandonment of gas guzzlers by American consumers continues, with last month's sales of domestically manufactured light trucks (which includes the once almighty SUV category) down 28% from June 2007.

Data source: Wardsauto.com

Sales of imported SUVs, which had been holding up better, plunged even more dramatically.

Data source: Wardsauto.com

For the lighter car category, sales of domestics fell 13%,

Data source: Wardsauto.com

while imported cars, which tend to get better mileage, eked out a 4% gain:

Data source: Wardsauto.com

The shift is a necessary change in the long run, but in the short run will definitely put additional strains on the U.S. economy, as it's precisely this kind of disruption in domestic spending that appears to be responsible for the contribution that historical oil price shocks have made to previous U.S. economic recessions. FT conveys some of the gloom:

The US car market is heading for its worst year in more than a decade as Americans turn their backs on large, gas-guzzling vehicles, according to June sales data due out today.

The figures come as the big US carmakers scramble to adapt to the dramatic shift in demand to more fuel-efficient cars and crossover vehicles. Chrysler yesterday said it would close a US minivan assembly plant and cut one of two shifts at a pick-up truck site. Chrysler's move will result in 2,400 job losses at the plants, both in St Louis.

There are even dark murmurs that GM, once the biggest company in America, could conceivably be forced into bankruptcy.

Is there relief in sight from the continuing rise in oil prices? I noticed this cheerful bit from WSJ Real Time Economics:

"Overshadowing all the economic data is growing speculation that Israel is gearing up to destroy Iran's uranium enrichment plants," said Bernard Baumohl of the Economic Outlook Group. "We assess the probability of such a military strike to be 85%, and that it will likely occur between September and November."

Maybe they're just trying to scare us.

Maybe they're succeeding.

Technorati Tags: macroeconomics, autos, auto+sales, gasoline demand, economics, recession, gas prices, oil shock

Temecula, CA. Source: Los Angeles Times.

Temecula is a community in southern California some 60 miles from downtown San Diego and not a whole lot closer to anywhere else. And yet I've known people who commute to work here from Temecula, having been willing to trade driving time for more affordable housing. The population of Temecula doubled over the last decade.

But with gas now nearing $4.50 a gallon in San Diego, the housing-commuting tradeoff is looking a lot less favorable for these exurban communities. Via Calculated Risk, the Los Angeles Times reports that as many as 15% of the homes in Temecula are currently either bank-owned or in some stage of foreclosure.

If you make your living trying to provide goods or services to those residents, higher gasoline prices are hitting your wallet by much more than the cost you personally pay for your own gasoline.

Source: New Jersey Gas Prices.

Technorati Tags: macroeconomics, housing, oil, oil prices, gas prices, oil shock

The sharp spikes in oil prices associated with the 1973-74 oil embargo, the 1978 Iranian Revolution, the Iran-Iraq War in 1980, and the first Persian Gulf War in 1990 were each followed by an economic recession. However, when oil prices started to rise again five years ago, many of us suggested that things would be different this time, in part because the price was rising much more gradually and so should be less disruptive of consumer spending patterns. Others emphasized that, despite the price increases, oil was still cheaper than it had been historically if you took into account inflation. However, once you include the most recent data, neither of those claims would still be true.

Average monthly dollar price of West Texas Intermediate (from FRED divided by ratio of contemporaneous to March CPI (also from FRED).

Another reason consumers had been largely shrugging off the oil price increases of the last few years is that they could afford to do so, since energy expenditures had fallen so significantly as a fraction of total income. However, as a result of rising oil prices, that, too, is no longer the case. The graph below shows a rough estimate of the dollar value of U.S. crude oil consumed as a fraction of GDP. This ratio fell as low as 1.1% in 1998, but is up to 5.2% so far in the first quarter of 2008. And that's on the basis of the average 2008:Q1 oil price of $98 a barrel-- you'd pay $128 as of today.

One hundred times the ratio of (1) annual average of monthly WTI price per barrel (from FRED) times annual U.S. crude oil consumption (from EIA) to (2) annual nominal GDP (from BEA Table 1.1.5).

We've reached the point where American businesses and consumers simply can no longer afford to ignore the price of fuel, and we're getting clear indications of real changes in behavior. Counts of the number of cars on the roads suggest that U.S. vehicle miles traveled fell 4.3% in March.

U.S. vehicle miles traveled in billions of miles, 12-month moving average. Source: Federal Highway Administration.

U.S. gasoline consumption so far in 2008 has been 70,000 barrels/day lower than in the first five months of 2007.

U.S. finished motor gasoline product supplied, 4-week averages, in thousands of barrels per day. Most recent year in red, previous year in blue. Data source: EIA

And sales of SUVs are crashing. Sales of light trucks manufactured in North America last month were 26% below the level of May 2007.

Data source: Wardsauto.com

How do the challenges this poses for domestic automakers compare what we observed in the 1990 oil price shock? BEA Table 1.2.6 indicates that the real value of U.S. motor vehicle production fell by $44 billion between 2007:Q3 and 2008:Q1, almost as large as the $49 billion drop between 1990:Q3 and 1991:Q1 following the oil shock associated with the first Persian Gulf War. Granted, autos were more important for the U.S. economy then than they are now, with $49 billion representing 0.7% of GDP in 1990 (or a 1.4% hit to the annual growth rate), whereas the $43 billion drop between 2007:Q3 and 2008:Q1 is little more than half the size of the 1990-91 shock relative to GDP. On the other hand, the monthly auto sales data graphed above show that April and May marked a significant deterioration relative to 2008:Q1. BLS seasonally unadjusted establishment data indicate that the number of Americans employed in motor vehicles and parts manufacturing fell by 107,000 between April 2007 and April 2008, which is bigger than the 88,000 decline between April 1990 and April 1991. GM this week announced plans to close 4 North American plants, idling an additional estimated 8,000 workers. Ford plans a 15% cut in its 24,000 salaried employees.

Continental Airlines announced plans to cut 3,000 jobs in response to higher fuel prices, following similar announcements from United, Delta, and American Airlines. Based on the experience in earlier oil shocks, we can anticipate that there will be broad changes in many other categories of business and consumer spending that will pose challenges to a number of affected industries.

We dodged a recession (at least through most of 2007) despite a dramatic housing downturn. The modern American economy could perhaps also continue to grow through the kind of effects we saw from the oil price spike of 1990. But what if we have to deal with both sets of problems at the same time?

I'm afraid we're about to find out.

Technorati Tags: macroeconomics, autos, auto+sales, gasoline demand, economics, oil shock, gas prices, oil, recession, airlines