As the pump price of gasoline climbs up towards the $4 per gallon prices reached in the summer of 2008, anxieties increase over the potential negative impact on a still struggling economy. As more money is spent on fuel, less is spent on other items. In an economy struggling to close the gap between too little demand and supply, our addiction to cars and light trucks poses a threat to what is still a nascent recovery.
The fleet on the street today averages a higher miles per gallon (mpg) than the fleet of 2008, which helps a little. Those fleets with lower mpg were hit the hardest during the recession.
Daimler-Chrysler: 28.6 mpg (-36% overall sales)
Ford: 29 mpg (-28% overall sales)
General Motors: 29.9 mpg (-18% overall sales)
Toyota: 31.6 mpg (-21% overall sales)
Honda: 33.5 mpg (+1.1% overall sales)
Daimler-Chrysler: 24.7 mpg (-36% overall sales)
Ford: 29.9 mpg (-28% overall sales)
General Motors: 31.9 mpg (-18% overall sales)
Toyota: 38.5 mpg (-21% overall sales)
Honda: 39.6 mpg (+1.1% overall sales)
Ford: 22.2 mpg (-28% overall sales)
Daimler-Chrysler: 22.6 mpg (-36% overall sales)
General Motors: 22.6 mpg (-18% overall sales)
Toyota: 23.9 mpg (-21% overall sales)
Honda: 25 mpg (+1.1% overall sales)
That said, it’s expected that the industry will average 29.2 mpg over model-year 2011, including 33.7 mpg for passenger cars and 25.1 mpg for light trucks; that’s well ahead of the federal standard, but in anticipation of tighter standards being phased in, leading up to a 34.1-mpg average in 2016.
This trend means the fleet today is at minimum running at a 10% better mpg. Better, but when the price of gasoline goes up by 30% in a short period of time, as it appears it will, then the negative impact on demand will be unavoidable. The problem is that no one has a firm grip on just how much spending declines as gasoline prices rise.
From an 2008 article by the University of Southern California:
“Because it is difficult to reduce spending on gasoline, the effects of price increases are often shifted to other economic sectors. Some economists estimate that for every one cent increase in the price of gas, spending in other areas will decline by one billion dollars. This figure does not appear to be based on recent empirical data, but it is clear that gasoline prices significantly affect consumer spending. In 2007, Wal-Mart estimated that the then current higher gasoline prices take away $7.00 per week from an average family budget. Since then, this figure has certainly increased significanly. The problem is compounded by the so-called “Multiplier Effect,” whereby money is re-spent as it makes its way through the economy. (E.g., restaurant workers buy movie tickets and studios in turn hire actors and staff, who in turn spend their money, giving income to others who in turn spend….) Because a large part of the cost of oil goes abroad, there is less opportunity for multiplication within the U.S. economy.”
If this is a correct correlation, (+1 cent gasoline = -$1 billion demand loss) then an 86 cent increase to $4 gasoline at the pump means an $86 billion drop in demand. While that appears small compared to a $14 trillion national economy, it is the marginal dollar that determines whether an economy is growing or shrinking. Minor changes in this trend can have major impacts on the economy.
Another difference between 2011 and 2008 is that this gasoline price rise is not being accompanied by a major financial catastrophe with its roots in a bursting housing bubble. The $4 gasoline in the summer of 2008 didn’t help the economy, but it was not the proximate cause of the Great Recession.
The truth is that automobile manufacturers are ahead of the federal government standards. A number of major companies have announced they will be at 40-50 mpg on most of their vehicles by 2025.
A final wrinkle is that as better mpg is achieved consumers tend to increase their use of cars and light trucks thus ‘sterilizing’ somewhat the benefits of mpg gains. The demand for gasoline, in other words, is somewhat ‘inelastic.’ It takes a major price increase to substantially reduce gasoline consumption. The downside of that inelasticity means the spending comes more out of someplace else, not gasoline use.
We’ve argued before that our over reliance on petroleum puts a ceiling on our economic recovery. Until we figure out a way to substantively reduce this reliance, our economy can only grow slowly.