Will Dropping Oil Prices Boost Economic Activity?

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By Jacob Maslow

falling oil prices - roller coaster
Falling oil prices and plunging fuel costs as a group of oil barrels in a shopping cart going down on a roller coaster.

One of the most popular conclusions analysts share regarding the continuing decline of oil prices is increased consumption. According to this view, if prices at the pump continue to crash, more people would look at their savings as a tax cut or a bonus. In other words, they would spend that surplus. It didn’t exist before, now they can spend it on other things that they wanted to buy previously but had to spend on gas.

While there is a lot to recommend this analysis, it only has limited use. It is only useful up to a certain point. You have to understand that, even if consumption is boosted by decreased spending on petroleum products, this might not be enough to offset the overall slowing economy. Put more broadly, for every job lost in North Dakota and Texas due to the crash in oil prices, there might not be enough new jobs generated elsewhere due to increased consumption. There is this translation cost: between direct oil-related job losses and new jobs being created due to increased consumption.
Moreover, the decrease in oil prices is also accompanied by an increase in the value of the U.S. dollar. A strong dollar prevents the U.S. from exporting its way out of any economic slowdown. In fact, there might be a deflationary spiral brewing in the U.S..
As prices drop due to low oil prices, consumers might hold off on major purchases, and this might trigger further reduction in prices. Further reduction in prices might then lead to companies becoming more and more unprofitable. At the very least, companies may be less willing to hire. Put altogether, the continuing decrease in oil prices might lead to a deflationary spiral in the U.S. – that can lead to bad news for the general economy.
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