Acute Pain at the Pump

 | Feb 06, 2013 | 4:30 PM EST  | Comments
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I probably don't even need to point out that gas prices have been rising of late. We know that there are certain causes for such a climb, such as refinery issues or a switch to summer blends -- and, of course, part of the price hike relates to crude-oil pricing. One potential question here is: What might happen to consumer spending? Another: Are the Federal Reserve's monetary policies having an effect?

To address the first question, gasoline expenditures account for roughly 5% of consumer spending, in aggregate, based on the Personal Income and Outlays report from the Bureau of Economic Analysis. Gas prices have risen by about $0.28 per gallon since mid-December to reach a national average of $3.53, per the U.S. Energy Information Administration. We can see the recent history below:

Gas Prices

If we base our analysis on numbers only and not mood, we can objectively see that gas prices were higher last year than they are now. We can also quantify that the 8% increase here would shave about 0.4% off consumer buying power, given the share of gasoline among aggregate household budgets. At first glance, this might not seem like a tremendous amount, and mathematics might not argue for us to be concerned.

But this ignores the fact that, along with this price hike, consumers have additionally seen their pay decline with the expiration of the payroll tax cut. That was a temporary 2-percentage-point reduction in Social Security withholding taxes, and the end of the tax cut means a 2% take-home pay cut for many households.

The combination of this and higher gas prices could presumably affect consumer confidence. As a result, consumers may potentially cut spending by more than simply a dollar-for-dollar offset of the rise in gas prices and the end of the tax cut. This effect is amplified by the high-frequency nature of gasoline purchases, and the constant reminders of the high price gas prices at every service station. Of course, historically, we've at best seen an imperfect correlation, between consumer confidence and consumer spending. So we cannot make any predictive inferences from any change in consumers' collective mindset.

At this point one might ask, why are petroleum prices rising? Certainly this may be explained by geopolitical tensions, growing economies around the world or a cutback in production by OPEC. But, you might ask, could the Fed's easy money policies also play a role?

Yes, actually, they can, according to researchers from the New York Fed in a recent paper (PDF). The researchers determined that oil prices are responsive to the Fed's asset purchases, as well as changes in the federal funds rate. The researchers believe that the effect on the U.S. dollar is the mechanism by which oil prices respond to Fed actions, or to policy meetings. The researchers posit that the easy money policies cause the dollar to be weaker than it would otherwise be, and that this has made oil more expensive to U.S. consumers.

Because oil is generally priced in dollars, it becomes more expensive when the dollar weakens: Each dollar buys less oil than it would have done had crude been priced in another currency. We can see this inverse relationship between the value of the dollar and oil below:

Dollar Index vs. West Texas Intemediate crude

Because crude oil prices account for 68% of the cost of a gallon of gas, according to the Energy Information Administration, we cannot ignore the Fed's indirect impact on gas prices. The EIA also notes that the other costs of gasoline include refining (8%), marketing and distribution (11%) and taxes (13%).

Of course, the New York Fed researchers note that oil prices also react to U.S. economic data, and not just Fed policy and currencies -- so better economic data may also bring about higher oil prices. Thus, in an odd sort of way, a part of higher petroleum prices might reflect improving economic fundamentals, at home and abroad, including in China. This, in turn may somewhat offset gas-price and consumer worries.

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