Although the unrest in the Middle East had some effect on prices, most of the reason why oil prices rose can be traced to global demand increasing. As economies recovered, they needed more oil. Since supply didn't rise in response, the price increased.
The Troubling Loop
In July, however, the economy appeared to begin improving again, compared to May and June. This is likely due to spending returning. Retail sales were up by 0.5% during the month, the best growth since March. Why are Americans spending more? That's easy: gas prices began to decline again. Since early May, they're down about a quarter per gallon, or 7%.
Indeed, prices are expected to continue to fall, since the global economy has been weak over the past couple of months. But as gas prices decline and spending returns, the economy will begin to strengthen again. And as it gains steam, gas prices will presumably begin rise in response.
When that happens, can we expect consumer spending to pull back again, once gas prices approach $4 per gallon? Probably, since that's what happened last spring. You can see how this cycle can continue over and over again. We'll never have a strong, resilient recovery as long as the economy begins to slow just as it finally gains traction.
Why Gas Prices Matter So Much This Time
Why doesn't this happen in other recessions? For one thing, Americans are extra sensitive to gas price increases in this recovery. As long as unemployment is high and the real estate market is weak, sentiment will have a hard time rising to a level where people feel comfortable enough to absorb a significant increase in energy costs.
Think of it this way: the U.S. economy is like a patient that has a serious illness from which it can only slowly recover. If that patient contracts some infection, then her condition will worsen. Only if she stays as healthy as possible will she gradually recover. Rising gas prices are like an infection attacking the economy's already weak immune system. If the economy was healthier to begin with, gas prices wouldn't have as significant an effect.
Searching for Solutions
Any solutions to attempt to help the economy to heal faster need to address either its underlying weaknesses, like the housing market or unemployment, or ensure that rising gas prices don't prevent a prolonged hiring spree. The housing market problem will be tough to fix quickly, due to its severity and logistics, though some policies might help more than others. The government can only help to cut unemployment directly through job programs, for which there's little money or will in Washington to create.
That leaves gas prices. The U.S. may want to consider creating a price ceiling for average gasoline prices, perhaps at around $3.50. In order to ensure that consumers don't have to pay more than that for gasoline, one step could be to relax taxes when prices begin climbing past that mark. When taxes can't be lowered any farther, perhaps subsidies can help cut prices.