Was It Energy Prices, Not Housing That Caused The Recession?

What would you think if someone told you that all of the reasons advanced so far about the causes of this nasty recession were false and that there was another very simple explanation? If you’re like me you might want to not know about it. Throwing out all of the notions, ideas and conclusions running around your brain isn’t the most pleasant of prospects.

Well, James Hamilton is proposing that the whole mess is the result of the energy shock that rising oil prices delivered to the economy. In a paper that he presented to the Brookings Institution he goes back to 2003 and drawing on historical data of what an oil shock of the magnitude we experienced in 2008 would do to the economy. Here is the graph he produced to demonstrate the result:

As you can see, the predicted path of the economy based on his hypothetical case is remarkably similar to the actual path. Hamilton professes to be shocked by the outcome of his research and even goes so far as to say that he has trouble believing in the results. Simple answers are often the hardest to accept.

He notes that the housing sector rather than being the prime cause of the crisis was only moderately impacting GDP at the time the oil shock occurred. That event then accelerated the decline in housing which ultimately overwhelmed the financial sector.

Here is how his paper concludes:

Eventually, the declines in income and house prices set mortgage delinquency rates beyond a threshold at which the overall solvency of the financial system itself came to be questioned, and the modest recession of 2007:Q4-2008:Q3 turned into a ferocious downturn in 2008:Q4. Whether we would have avoided those events had the economy not gone into recession, or instead would have merely postponed them, is a matter of conjecture. Regardless of how we answer that question, the evidence to me is persuasive that, had there been no oil shock, we would have described the U.S. economy in 2007:Q4-2008:Q3 as growing slowly, but not in a recession.

I’m still digesting all of this. If his argument is valid then there are implications for policy choices regarding recovery from the recession and certainly for energy policy. Some might argue that it is a great endosement of the need to move to renewable energy sources, others that it suggests we have to drill like mad men in order to insure against further shocks.

What can’t be argued is that the economy can quickly adjust to a major increase in energy prices. Whatever path policy is to take, it has to pay particular attention to the imperative of maintaining energy price stability.

I almost hope he’s wrong. I really don’t feel like rethinking things.

more: here

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