Oil and gas prices are ‘a drag on the economy’ but won't trigger recession: Expert

James Hamilton, professor of economics at the University of California at San Diego, joins Yahoo Finance Live to discuss how rising oil and gas prices amid COVID-19 lockdowns in China and the Russia-Ukraine war could affect the U.S. economy.

Video Transcript

- James Hamilton, who is a professor of economics at the University of California at San Diego. Professor Hamilton, it's great to have you on the show. There's no doubt that there's been a lot of fixation on what's going on in energy prices. Americans are feeling this at the pump. And I know you've done a lot of extensive research on whether or not these types of energy shocks have enough potential to tilt us into a recession. It has happened before. What's your assessment of the situation today? And could you see energy prices being the trigger for the next recession?

JAMES HAMILTON: It has happened before. And we see some of the signs that are a bit concerning. Consumer sentiment, for example, is something that moves pretty strongly with gasoline prices. When gasoline prices are up, sentiment comes down. And it's now at the kind of levels that we sometimes see in a recession. However, I'm a bit optimistic as far as the direct consequences of what's happened so far with gasoline prices for the economy. And the reason is because of other aspects of what's going on in the economy.

So a recession really means a year to year decline in real GDP. What do we do this year compared to last year? And, for example, in some of the sectors where historically some of the effects were most concentrated, such as auto sector, last year, we were in a slightly depressed situation, partly because of the supply problems.

The automakers couldn't get the chips to build the cars. And that kept production down. When we're comparing with last year, even if there is an effect on auto sales at the retail level, I don't think it'll have the same kind of destabilizing effect. So my bottom line is what's happened with oil and gasoline prices so far is going to be a drag on the economy, but not a sufficiently big drag to by itself put us into recession.

- That sounds like that's where you see things as they stand now. I guess the question for me is, what happens if these prices stay the levels that they have been for several months? Right now, it looks like--

JAMES HAMILTON: No, I'm assuming they will stay. Yeah. I'm assuming they do stay. So when I say what's happened so far, I mean prices where they are, where they have been. The uncertainty in my mind is, for example, what's going to happen with Russia and Ukraine. Is there going to be a significant decrease beyond what's happened already in Russian oil and natural gas production? And that, if it happens, will make the prices go much higher. And that would be an additional strain on the economy, particularly the European economy.

- And then I want to ask about just kind of how this would possibly work. There are many ways by which rising prices can lead to a recession. But it seems like a lot of the financial commentary that we've seen so far is that this could be a Federal Reserve-induced recession in response to a very aggressive amount of interest rate hikes to get ahead of high inflation. So is there a bleed through from commodities prices to headline inflation to the Federal Reserve's hiking that kind of builds this narrative of the possible recession if there is one in the next few months or years?

JAMES HAMILTON: Potentially. But one of the things we look at when we talk about monetary policy is the real interest rate. The difference between the nominal rate, which is what the FOMC decides at every meeting, and the inflation rate. And that difference, the nominal rate minus the inflation rate, is quite negative at the moment. And a negative real interest rate is not by itself a big depressing effect on economic activity.

I think the connection comes more through the direct channels on the real side of the economy of the price increases. A lot of people, when you go to the gas station and your tank is empty, what do you do? You don't really have a choice. You pay. And there are adjustments you can make in your consumption of gasoline in the short run. You can try to take public transportation or carpool or move closer to work or get a new more fuel-efficient car or an electric car. But those things take time.

And a lot of people, at least in the short run, the main thing they do when they see gas prices go up is they pay the extra cost and cut back on their spending somewhere else. And that cutback in spending can be then a destabilizing factor somewhere else. For example, auto sales. That's something in the historical episodes where we saw when the gasoline price went up, there was a big drop in auto sales, particularly the less fuel-efficient cars. And that was a contributing factor.

- James Hamilton, UC San Diego professor of economics. It's good to have you on today. Appreciate your time.