Wednesday, August 24, 2011
Pursuant to yesterday's discussion, let's think a bit more quantitatively about what kind of constraint oil supply places on fiscal stimulus. The blue curve above shows the path of gross world product, in trillions of 2010 dollars, measured at purchasing power parity.* 2011 is the IMF's projection. The red curve shows what might have happened in a counterfactual world had the world's governments followed a perfect fiscal stimulus path that exactly compensated for the loss of aggregate demand due to the fiscal crisis and overleveraged consumers in the developed world. I've implemented this as GWP growing in 2008-2011 at the same average growth rate as had occurred in 2000-2007.
2009 is the year in which it's easiest to see the issues. In the counterfactual world, 2009 gross world product would have been 6.4% larger than in the actual world. We can estimate the implications for oil supply because we know that the global income elasticity of oil demand is about 2/3. Thus the counterfactual world would have required an additional 4.5% more oil than the real world (other things being equal).
The actual path of oil production and price looked like this:
Here various estimates of production are on the left scale and monthly oil price is on the right scale. 2009 oil production was around 85mbd (depending on what source you like) so in the counterfactual world we would have needed it to be around 88-89mbd. Now, in 2008, oil production got up to around 86mbd (on an average basis) but doing so triggered (or required) an oil shock in which prices briefly reached $135/barrel on a monthly basis and almost $150 on a daily basis. What would the likely price path have been had the world then needed an additional 2-3mbd the following year?
To give an indication of the scale of 2-3mbd, note that the loss of 1.6mbd of oil this year (Libya) triggered something like a $30 increase in the price of oil (before it became clear that the global economy was slowing again causing prices to fall). That, along with other commodity price increases, was enough to cause a little bump in inflation that significantly reduced the Federal Reserve's latitude for action.
My guesstimate is that in the counterfactual world, oil prices would have continued their rise and hit $150-$200 in 2009. Poor Matt Simmons might even have won his bet. I think that, in turn, would have undoubtedly been high enough to affect world growth negatively.
* The idea of purchasing power parity is that, especially in developing countries, the price of goods and services may be very different than in the US when measured at market exchange rates. Let's say a $20 haircut in the US is $5 in China. To construct a PPP estimate, we want to value that haircut at $20 rather than $5 and that's what the IMF (source of this data) attempts to do. The IMF doesn't seem to directly make available a real (ie inflation adjusted) series for PPP GWP however, so I use the nominal series they do provide and then deflate it with US GDP deflators from the BEA.