Former IMF Chief Economist Olivier Blanchard, reacting to recent financial market turbulence, noted that the market reaction isn't supported by “fundamentals.” In particular, lower oil prices should be on balance a net positive to global growth. My friend Torrens Hume, meanwhile, has a nice post on his blog Specie Flow that breaks down the effects of lower oil prices. While I agree with both, I have a slightly less benign view.
Lower oil prices undoubtedly raise real incomes of oil-importers. Of that there should be no controversy. And, since there are more consumers of oil than producers of oil, this should be beneficial to global growth. There is a "but," however; that increase in real incomes of consumers will only add to global growth if it is spent; if it is saved (or used to pay down debt burdens) it won’t necessarily translate into higher growth.
My worry is that, in an environment of great uncertainty, consumers will hoard the purchasing power represented by lower oil prices. Savings may rise. “Hold on,” I hear you say. “In equilibrium, savings equals investment, so it doesn’t matter that consumers aren’t spending.” True enough, but uncertainty may also lead firms to exercise the option value of waiting — holding off on investment until there is clarity about where the global economy is going, what the Fed will do with interest rates, whether the international community is serious about climate change, etc.
For the avoidance of doubt, I am not referring here to measures of uncertainty based on references in the press, or the simple-minded assertion that President Obama’s policies have hurt business confidence. On the contrary, the problem I am concerned about is the damaging effects of a failure to move briskly to full employment, and dysfunctional monetary arrangements and “markets for lemons” banks. The business of business is investment — to provide goods and services for consumption, but if firms are unsure that future demand will be forthcoming because of weak household demand they may hold off.
Admittedly, the situation in the United States is much improved and these concerns are likely less relevant today than, say, a few years ago. Moreover, I frankly don’t know how important this potential effect might be — I am simply not close enough to the data to know. It is an empirical question, for example, how robust US investment is; to what extent recent investment reflects the fracking revolution, which has transformed the US energy market, and the services that support it. It can even be said that the situation in Europe has improved considerably.
All of that said, it is possible that recent market turbulence reflects the fact that we remain in the New Age of Uncertainty.