Deeper dives into prices and worker pay show that the war against inflation is not yet won. There...
The wild ride of gas prices
The economic impact of gas price fluctuations is different today than in the past
- Gas prices are ending 2022 near where they started, after setting record highs this summer
- Important developments have led to gas prices having less of an impact on the overall economy
- The long-term future of gas prices and their relationship to the economy is uncertain
Gas prices have been on a wild ride in 2022
This past year has been a wild one for the cost of gasoline. Changes in the price at the pump are something we notice and feel on a regular basis. And, as the chart below shows, there’s been no shortage of excitement for gas prices during 2022.
After starting the year near $3.30 cents per gallon, the national average price of gas skyrocketed to a new record of just over $5 in June. But this surge didn’t last long, as prices have now fallen over 30% off peak levels, back near where they started in January 2022.
So, what’s driving all this excitement? The single largest component of gas prices is the cost of oil, which makes up over half of what we pay at the pump. And this year, the primary factor driving oil prices has undoubtedly been uncertainty.
It’s no surprise that disruptions in the first half of this year like a shaky global supply chain, Russia’s invasion of Ukraine, and OPEC’s slashing of production targets all contributed to higher costs.
Throughout the second half of the year, despite day-to-day fluctuations, the overall trend has been a drop in oil prices. This is largely due to the market having become accustomed to the factors driving today’s uncertainty, which has allowed the oil market to calm down.
Even last week’s news of additional sanctions on Russian oil and reaffirmed cuts in OPEC supply did little to buck the trend of falling oil prices. Many analysts think the oil market will maintain its calm through the end of the year, allowing gas costs to fall even further—the price at the pump is expected to drop below $3 per gallon over the next few months.
But while falling gas prices come as welcome relief for consumers struggling with higher inflation, the overall impact on the economy might not be as significant as one would imagine.
In today’s world, gas prices do not control the economy
Memories of energy-shock-induced recessions crept into the minds of many as gas costs climbed higher earlier this year, prompting fear about the economic consequences of higher prices at the pump. But unlike the 1970s, gas prices do not determine the fate of today’s economy.
Two developments over the last few decades are responsible for this fact: more efficient vehicles and relatively more affordable gas when adjusting for inflation. The combined effect of these factors has led to a 50% reduction in the real cost of driving a mile since 1980.
This means that increases in gas prices pack far less of a punch today than in the past. Pain at the pump still creates unwelcome challenges for today’s consumers, but the power of gas prices to cause widespread economic devastation has been greatly reduced.
Consider another recent period of high gas prices, from 2011-14, when the real cost of gas (adjusting for inflation) rivaled today’s costs for almost four straight years.
The real price of gas, represented by the blue line, was as high as it had been in 30 years. But the purple line shows that the economy just continued growing during this time. Additional improvements in the fuel efficiency of vehicles since then make today’s economy even more desensitized to gas price hikes.
So, while high gas prices hurt, it takes more than just pain at the pump for an economic downturn to occur. Conversely, while a recent reduction in gas prices might provide some relief to consumers today, it’s unlikely to create a widespread surge in economic activity.
What does the future hold?
Gasoline is a vital component of our economic lives, so the wild ride of gas prices over the past year has presented many challenges. And while we’ve seen some relief from our pain at the pump as of late, the future remains uncertain.
Short-term influences like geopolitical factors contribute to this uncertainty, as do longer-term trends like the pace and path of the world’s transition to “greener” sources of energy amid global climate challenges. The factors that influence our overall energy future are hard to predict.
Nonetheless, it’s important for us all to understand that changes in gas prices do not dictate our economic fortune in the same way today as in the past. It’s important for investors to understand the nature of this relationship and focus on the broader long-term potential of the U.S. economy as a whole.