Does a falling Oil price lead to growth?

Since the Summer of 2014 Oil has fallen from over $115 a barrel to a low of $27 in January. It has since recovered and has spent the last month trading around the $40 level. Conventional wisdom suggests that a fall in the Oil price is beneficial for global GDP. A view that was supported by the IMF’s initial calculations, saying that global GDP increases by 0.5% for every $20 that the Oil price falls. Prior to the price fall the IMF predicted 4% global growth in 2016, with the Oil price fall accounted for this would suggest over 6% growth this year. Yet the IMF is expected to cut 2016 growth to 3.4%. So what has caused them to revise their estimates down to such lacklustre levels for growth?

Certainly there have been many other concerns limiting growth. The slowdown in China has caused two significant stock market drops in the last year, Europe is still lagging and major economies such as; The UK, US and Japan have failed to maintain a strong growing economy. But it is also clear that the expected boosts from a lower Oil price are yet to materialise.

Energy expenditure is a large part of the average consumer’s budget. Therefore, a fall in the price of Oil should leave people with more money to spend in other areas of the economy. That is what theory would tell you, but in practise this has not worked. In many countries taxes make up a large proportion of fuel prices and other countries have used the falling price of Oil as an opportunity to increase taxes. This was the case for India, where they increased taxes at the behest of the IMF. Even in countries where most of the fall was passed on to consumers, there has not been a rush to spend their extra disposable income. Saving rates have been rising and poor economic sentiment has dampened both spending and investment.

Another assumption made, was that a falling Oil price would transfer money from Oil producers to consumers and that any gains would outweigh the losses. Again, this seems to have been incorrect. This did not account for just how much Oil firms would begin to struggle. Investment has fallen massively, Rigs are left inactive and jobs have been lost. Furthermore, the Bank for International Settlements has estimated the Oil and Gas industry has run up a $3 trillion mountain of debt during the last boom. So once revenues diminished as the Oil price fall, governments were effected resulting in some cases of falls in public investment.

A lot of the fall in the Oil price can be explained by the supply glut. A proportion of the price fall has been a symptom of weak global demand and growth. So if weak growth has caused Oil price to fall, you cannot then expect a fall in Oil price to cause growth, in reality it just prevents growth from being even weaker.

It is still possible that the low Oil price will cause a pickup in growth as we move into 2017, as the expectation is that the lower price level will be maintained for longer. However, what the economy needs is an improvement in sentiment and confidence, so that consumers spend more and investment recovers. As economists can no longer rely on a falling Oil price to be a boon for growth.

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Reuters: Business News