Oil!

I'm a recovery optimist -- to me, the shoots are always greener -- but when I get nervous about the prospects for a strong return to growth, it's usually because I've been looking at oil prices. This is a personal hobbyhorse. Americans rely on oil to do a lot of stuff. Commute, obviously. To run errands, including those to pick up various goods shipped across the country by truck. To operate lawnmowers and gas grills and use any of the many, many household chemical products derives in part from petroleum. Oil used to be cheap, and we became very dependent upon it.

So when prices spiked last year, it felt like a massive tax on all kinds of activities and consumption. Massive tax hikes are strongly contractionary, and so the oil spike kicked us into recession, which had the nice palliative effect of pulling the rug out from oil prices.

But high prices are making a comeback. Having fallen into the $30 per barrel range during the darkest days of the recession, oil is now back over $63, and every piece of positive economic news kicks it a little higher. Meanwhile, the temporary drop in prices combined with the credit crunch to derail a lot of new investments in production and search. Demand is returning, and supply remains limited.

Not too surprising then that a new McKinsey study warns of the inevitability of another oil shock. The fundamentals remain in place, they note, and the stronger the recovery from the current recession, the sooner the potential spike may take place (see charts here). Under the best growth scenario, a steady rise in prices could give way to a spike as early as next year, and even a deeper recession than is currently forecast would merely delay a spike until 2012 or 2013.

There's not enough time to erase the threat from expensive oil; it took us decades to build this dependency, and it can't be erased in three or four years. But progress is possible. Given that a long-term stimulus investment boost may be necessary to return us to trend growth, it would make a lot of sense to direct a healthy share of that investment toward efficiency, transit, and research on petroleum alternatives.

Presented by

Ryan Avent is The Economist's economics correspondent and the primary contributor to Free Exchange, an economics blog

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