I say this because the oil price has fallen to a 27-month low this week. This means the fees we must pay to oil producers for producing goods and services, heating our homes and filling our cars have fallen. This is equivalent to a tax cut on both production and consumption.
Since June, the sterling price of oil has fallen by ten per cent. As the UK consumes 1.5 million barrels of oil a day, this drop saves us the equivalent of 0.2 per cent of GDP. This might not sound very much, but over 12 months it is equivalent to a 1p cut in employees’ national insurance contributions – something which everyone would welcome. In the US, the benefits are even greater, as the country consumes more oil per person, and because the benefit of the lower oil prices hasn’t been mitigated by a weaker exchange rate.
The effects of this will be the same as a cut in any tax on production; prices should fall and output will rise, thus creating jobs. Andrew Oswald at Warwick University has shown that changes in oil prices have explained a surprisingly large proportion of the fluctuations in unemployment since the War. Indeed, it might be that part of what we think of as secular stagnation is in fact the effect of a trebling of oil prices since the start of the century.
You might think that what’s good for the economy should also be good for share prices. You’d be right. But there’s a wrinkle here. Research by the University of Edinburgh’s Ben Jacobsen and colleagues has found that lower oil prices lead to higher share prices around the world – but with a lag, so that lower oil prices one month are associated with higher equity returns the following month. Investors, it seems, initially under-react to moves in oil prices – perhaps because they regard them as so noisy as to convey little signal.
So far, so good. There is, however, a problem here. Economists believe that a big reason for the drop in oil price is the slowdown in the Chinese economy. This poses two risks.
One is simply that the benefits to western economies of lower oil prices will be mitigated by weaker exports to China. This is more of a problem for the euro area than for the UK and US, so it might exacerbate growth differences between the three economies.
The other is more diffuse, but might matter. A world in which China is no longer a locomotive of global growth would be a new paradigm which would bring into doubt of the presumptions we’ve had about the world economy – not least the fact that China’s massive savings glut has held down western bond yields. Uncertainty about this new world could hold back stock markets.
