What Happened to Gas Prices?

Gas prices are starting to rise from lows they experienced this winter, so it’s a good time to ask: did we ever get the economic stimulus we were promised and that some retailers were expecting?

Economic data shows that the economy didn’t exactly go gangbusters in the first quarter, so it looks increasingly like we just got cheap gas, but without the economic benefits. Why were economists—like Goldman Sachs economists, for example, who predicted that lower gas prices would have the economic effect of a $125 billion tax cut—so wrong? And what lessons can business and policymakers learn from this experience?

First, let’s take a second to defend incorrect economic forecasts: forecasting is difficult, but useful. In general, the more useful the forecast, the harder it is to get right—if you spend long enough with some SEC filings, you can forecast how much market share Chevy should expect to get this quarter. Not exactly saving the world. On the other hand, if you want to gauge how many people will be unemployed in two years and what that means for economic policy, that’s much harder—and, of course, far more important.

So while predictions are good, they’re usually incorrect. What went wrong with the theory that we were going to get an economic boost from low gas prices? Let’s take the major economic insights used as a foundation in forming this prediction, and see where they faltered.

(1) When the economy is weak, extra spending creates incentives for companies to invest and create products to meet additional demand, so the spending stimulates the economy. Here we should expect extra economic growth, so long as consumer spending increased.


Take a look at the data (this is retail sales excluding gas), and you can see that the bounce in consumer spending just didn’t happen in the second half of last year. The problem isn’t with our understanding of what extra spending does in a slow economy — it’s that the extra spending never happened in the first place. But why is that? In short, people saved the money, reducing their debts rather than buying more stuff. You may spend money paying a credit card bill, but that doesn’t produce real goods and services. It just changes your account balance.

The key question going forward, then, is why people saved their money.

There are two leading theories for this question: either households are carrying so much debt that when they have additional disposable income they spend it on debt reduction rather than on themselves, or that they thought the dip in gas prices was a short-term blip and didn’t react.

If the deleveraging story is correct, it means that short-term tax cuts — a favorite stimulus tool for many policymakers — likely won’t work to help kick start a slack economy when debt levels are very high. With a few years’ more data, we should be surprised if there aren’t a bunch of economic papers using this fall in oil prices to gauge how consumer spending and the economy as a whole would react to a short-term tax cut.

The deleveraging explanation points to a larger question. Has Americans’ behavior been permanently affected by the great recession? Behavioral economists have shown that Americans who lived through the Great Depression are more risk-averse than those who didn’t, and that the effect lasted for decades, if not their whole lives. It’s possible that the Great Recession has shifted Americans’ view of debt fundamentally, but we won’t know for quite a while if that’s the case.

But in the short-term, there’s more we can say about the blip question, so that’s the place to focus. That doesn’t mean it’s an easy question to answer: gas prices are basically determined by oil prices, which are really hard to predict. More importantly, we need to know what people think about future gas prices, which is even harder to determine.

The working hypothesis of economists for a long time was that when people can’t make any better prediction than the current price, they just use today’s price as a rough approximation of where prices will be in the future. Some economists have even tested this theory with gas prices and found that it holds up pretty well most of the time.

But there’s another economic factor we can use to cross-check what consumers believed about gas prices this winter: if prices spike and everyone buys a Prius, that suggests people think the price spike will last a while. Hybrids are more expensive upfront, but cheaper over time—even more so if gas is expensive. If prices spike and people buy gas guzzlers, it suggests people think price spikes are temporary.

Here we get some real-time data. First, people are buying cars and trucks at a rapid clip — suggesting that they aren’t holding off to find out what’s going to happen with gas prices. Meanwhile, the fuel efficiency of what we’re buying has been flat since late last year. Based on the real-time data we have, the blip story looks like a winner.

Now the question is, will people adapt to these lower gas prices over time and start spending some of their newfound disposable income? Stay tuned.


Michael Madowitz is an economist at the Center for American Progress.

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