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Will higher gas prices derail the economy?

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POSTED February 29, 2012 8:21 p.m.


 

NEW YORK (AP) — The price of gas has jumped 45 cents since Jan. 1 and is the highest on record for this time of year, an average of $3.73 a gallon. On Wall Street, talk has turned from the European debt crisis to another worry: Will higher gas prices derail the economic recovery?

Not yet, economists say. They argue that the United States is in much better shape than early last year, when a similar surge in fuel prices weighed on economic growth by squeezing household budgets. Americans spent less on clothes, food and everything else.

Rising gas prices hurt less when an economy is improving than when it's slowing down. So economists expect other spending won't be badly hurt, at least for now. If gas breaks its record of $4.11 a gallon, however, all bets are off.

"Can the economy withstand the increase we've seen so far? The answer is yes," says David Kelly, chief market strategist at J.P. Morgan Funds.

The reasons:

— Jobs. The country has added 2 million over the past year. Those 2 million people with paychecks will spend them, which helps the economy. Lower unemployment also makes people feel better about the economy — and less likely to cut other spending way back.

— Job security. Unemployment claims, the best measure of layoffs, are at a four-year low. Fewer Americans are worrying about losing their job, so they can take the punch of higher gas prices and move on.

— A steadier housing market, the Dow Jones industrial average's clearing 13,000 and other signs of an improving economy also help. Add them together and consumer confidence is the highest in a year. More confidence makes people more likely to keep spending on other things even if gas goes up.

"The public will howl as we approach $4 gas, but they will probably continue to increase spending," says Carl Riccadonna, a senior economist at Deutsche Bank.

— Gas wasn't the only thing getting more expensive last year. Prices for milk, meat, bread and other foods were rising because of higher prices for grains and other farm goods. Natural gas prices were also on the rise, making it more expensive for Americans to heat their homes.

This year, natural gas prices have plummeted. Unlike like year, filling up the car's tank is about the only thing getting dramatically more expensive. Last year, when Americans were feeling it from all sides, they made tough choices, like cutting out expensive dinners.

— The increase in the price of gas has been more gradual this year, which could make it easier on the psyche of the American consumer. Last year, prices at the pump rose from $2.78 to a peak of $3.98 in mid-May. The national average for a gallon of regular on Wednesday was $3.73, up from $3.28 at the start of the year.

The key is what impact gas prices have on other spending in the economy. All consumer spending isn't equal. A dollar spent on gas has less of an impact on the U.S. economy than a dollar spent in a restaurant or at a baseball game. The U.S. is an oil-importing country, so many of the dollars spent on gas ultimately leave the country.

The rule of thumb among economists is that a 25-cent increase in gas knocks $25 billion to $30 billion off consumer spending in a year and lowers economic growth by 0.2 percentage points, says Carl Riccadonna, senior economist at Deutsche Bank.

The price of gas averaged $3.51 last year, so a move above $4 should only divert $60 billion from consumer spending this year, Riccadonna says. Last year, it drained an estimated $120 billion.

"It's really a two-horse race," Riccadonna says. "There's rising energy costs, and then there is households' ability to handle those rising costs."

So far, households appear to be keeping up. Economists think the economy will grow at a 2.2 percent annual rate in the first half of this year, compared with 0.9 percent while gas prices crept up in the first half of last year.

An oil shock would change everything. The scenario making the rounds on Wall Street starts with Israel bombing Iran's nuclear facilities. Analysts expect Iran would retaliate by trying to block access to the Persian Gulf, an attempt to pull 20 percent of the world's oil supply off the market.

In the event of a blockade, oil would skyrocket — think $150 or beyond — easily topping the record of $145 set in 2008.

"That's the wild card," says Kelly of J.P. Morgan. "That's the really big 'What if?'"

 

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