Four Rules of Thumb to Gauge How Oil Prices Hit the Economy – Real Time Economics

The price of oil is once again on the rise, along with fears that instability in Iraq could threaten the nation’s oil production and send global prices soaring.

A story in today’s Journal shows the U.S. may be more insulated from the hazards of the international oil market than in the past. But rising oil prices still have ripple effects on the U.S. economy. Here are some handy rules of thumb we worked out with Deutsche Bank chief U.S. economist Joseph LaVorgna to monitor how this could play out.

The Hamilton-to-a-Quarter Rule

The price of gasoline at the pump is closely related to the international price of oil. An increase of $10 in the price of oil tends to lead to an increase of 25 cents in the price of gas (a bank note with Alexander Hamilton to a quarter).

In fact, over the past six years, if you divided the price of oil by 40 and then added 75 cents you’d get pretty close to the national average price of gasoline.

So if oil trades at $120, it’s a decent guess that the national average price of gas will be around $3.75 (that is, $120/4 + $0.75). If oil falls to $100 a barrel, it’s a good guess that gas will head toward $3.25. This isn’t accurate enough for a professional oil trader, but it’s good enough to impress friends.

The One Penny-to-One Billion Spending Rule

From Mr. LaVorgna’s calculations, a one-penny change in the price of gasoline leads to roughly a $1 billion increase in household energy consumption. So if gas prices rise by 25 cents, that’d be a $25 billion increase in household energy consumption.

The 5-to-0.1 GDP Rule

Rising oil prices hit households in a couple of ways. First, when energy prices rise households and businesses immediately have to pay the new costs, effectively a tax on consumption. The energy producers don’t cycle that money back into the economy as quickly as the people spending it.

Since higher prices mean higher inflation, that extra spending doesn’t contribute to real GDP growth. Add all those effects together and a $5 increase in the price of oil translates to about a 0.1 percent hit to gross domestic product.

(It’s worth noting, Mr. LaVorgna adds, that these aren’t necessarily lasting long-term effects. Households eventually adapt to shifts in prices.)

The 10-to-1 Inflation Rule

Energy is about 10% of the consumer price index, which is mostly driven by oil, and so a change in oil prices will lead to a change 1/10th as large to the Consumer Price Index. So a 10% increase in energy prices will increase inflation by an additional 1% and a 25% increase in energy prices would increase inflation by about an extra 2.5%.

This is in addition to whatever other inflation is happening in the economy. So if most items are rising in price by 2% but gas surges upward by 10%, then you’d expect the annual change in the CPI to be 3% — the 2% for most items plus an additional 1% from energy.


So, in general, if oil rises from $100 to $110, what effects would we see?

From the Hamilton-to-a-Quarter rule, a 25 cent increase in the price of gasoline.

From the One Penny-to-One Billion Spending Rule, a $25 billion increase in household energy consumption

From the 5-to-.1 GDP Rule,  a 0.2% hit to gross domestic product.

And from the 10-to-1 Inflation Rule, a one percentage point increase in the inflation rate.

“It doesn’t always work but it’s a pretty good, simple, back-of-the-envelope calculation,” says Mr. LaVorgna.



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18 June 2014 | 2:06 pm – Source:

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