How do oil shocks cause recessions?

[GliderGuider]

http://www.financialsense.com/contributors/jeff-rubin/how-do-oil-shocks-cause-recessions">How do oil shocks cause recessions?

by Jeff Rubin

But by far the greatest impact that oil price shocks have on the global economy is the one they make on inflation and, hence, interest rates. This linkage is the means by which they have typically delivered a mortal blow to economic growth. Oil shocks have always given rise to growth-ending increases in interest rates as central banks are forced to respond to the inflationary fallout they leave behind.

The last recession was no exception. As oil prices soared from $35 per barrel in early 2004 to almost $150 per barrel in the summer of 2008, consumer price inflation in the US tripled to a rate of almost six per cent. It didn’t take long before interest rates caught up to inflation and, in the process, blew up the massively over-leveraged subprime mortgage market and the economy with it.

But lest we’d forgotten, it was the massive rise in energy inflation, and an associated rise in food prices (more on that in future posts), that catapulted the Federal Reserve Board’s federal funds rate from a nurturing one per cent setting in early 2004 to a level over five times that only a couple of years later. The rate of energy inflation rose from less than one per cent to as high as 35 per cent.

Oil prices caused the last recession, and oil prices will cause the next one as well. Energy inflation is already on the march. In fact, this time around oil prices are rising much earlier and much more rapidly than they did last cycle. Inflation is already running at nearly a five per cent rate in China; as oil prices go on to set new record highs, it’s only a matter of time of before we see those inflation rates in North America and in the rest of the OECD. And when we do, get ready for another oil-induced global recession.

My comment is that repeated oil shock recessions (especially if each one gets a bit worse) will eventually weaken the global social fabric enough that something, somewhere, will tear. I can't help but look at North Africa and wonder, Are We Witnessing the Start of a Global Revolution?

[Smashcut]

1. K/R

[Kolesar]

2. Third world countries won't be able to run their water works and the people will get dysentery

Because their municipal water systems run on petroleum fuels.

I am sure that the 1981 recession started due to energy prices.

I don't know what this means: "In fact, this time around oil prices are rising much earlier and much more rapidly than they did last cycle. "

[GliderGuider]

3. Oil prices rising faster than last cycle

I think he's talking about this: take a look at the first run-up from $50 to $90 from the beginning of 2005 to the beginning of 2008. Prices have risen the same amount over the same range since the beginning of 2009 to today, which is a year faster than the first rise - the same $40/bbl rise in two years rather than three.

I'm not a technical analyst, but the dips at the end of 2006 and in the middle of last year look suspiciously similar to me. It makes me wonder if there isn't another big spike waiting just out of sight to the right of the graph...

[Kolesar]

4. I recall broadcast news stories predicting $4/gallon gas this year

so that spike may be "just out of sight to the right of the graph"

[BeFree]

5. Oil

It is fossil fuel. It's been sitting there for millions of years. Free for the taking.
It is just capitalism which makes the prices rise and fall.

Since capitalism is our society's god we are at its mercy.

As long as we allow a few '' wanna be god'' capitalists to control the price of the otherwise free oil, we will be ripped off.