Friday, January 22, 2016

How Could Anybody Question That Low Oil Prices Lead To Low, Stock Prices?

On 1/17/16 Olivier Blanchard posted a piece entitled "The Price of Oil, China, and Stock Market Herding," which was picked by Mark Thoma at Economists View.  Here are two quotes from Blanchard's piece:

"Yet the headlines are now about how low oil prices lead to low stock prices."

then later in it:

"I believe that to a large extent, herding is at play"

I cannot agree more.  What has me ratttled on this and leading me to pile on is that the media seem to really believe this.  If one had only looked at daily market reports and TV and other media news headlines, this supposed tight link has simply become what they all say right up front without even a shadow of a question or doubt, even though as Blanchard notes most economists have long believed and argued that it is other way around: low oil prices generally lead to high stock prices.  But not now, and they seem to have lost all awareness of this older truth that dates back the stagflationary "oil price shocks" of the 1970s.

So, this is not only still happening but getting worse.  I just checked the markets.  Good news!  Oil price up and the stock market is sharply rising right now as I write this, at least as of a few minutes ago, and this happened yesterday, following the day before when oil fell being below $30 per barrel and fell and the market fell hard (along with ones around the world, especially in China).  Reality of this tight link, confirmed, and right now the news is good, supposedly.

OK, for a second let me note that most have been observing for decades the irony that in the long run higher oil prices are good by helping us get off polluting fossil fuels, even as in the short run it tends to a stagflationary effect: higher inflation and higher unemployment as real growth slows or even goes negative into  recession.

Indeed this past played an important role in the recent history of macroeconomics.  In the 60s we had the Phillips Curve.  Funny thing is that for all the rejections of it, it is back, and pretty clearly underlying the recent Fed rate hike has been some deep deep hankering at the Fed for  the Phillips Curve.  They had themselves screwed up to raising rates in September, but then China went blooey and later reports made it clear that Yellen managed to postpone a vote for that at FOMC by personally cutting a deal with crucial FOMC members that if the job market did well in the fall, the rate hike would happen, and indeed the job market did well, so Yellen had to keep her promise and the FOMC vote to raise rates in December was reportedly a unanimous vote.
A bit of irony on this is that initial rejection of the 60s version of the Phillips Curve during the 70s that coincided with the victory of the new classical approach was reinforced by the oil price shocks of 1973 and 1979.  So in 1968 Friedman and Phelps and others declared the existence of a long-run natural rate of unemployment at which point the long-run Phillips Curve would be vertical (and would also magically equal the auspicious NAIRU as well, although this never had a solid argument supporting it). Later this argument would be reinforced by rational expectations that would say that rational agents would all know indeed where that natural rate was, thereby precluding any meaningful downward slope of it, which would only appear as fools with inaccurate expectations would behave in a silly way.  Get thee hence, oh Keynesian Phillips Curve, you silly delusion fooling the wise new macroeconomists and policymakers.

Now many at the time and again later in the 80s, including all Post Keynesians and some more standard people like Larry Summers (and even Phelps always allowed for this as a big caveta), that unemployment is endogenous through hysteresis and other issues, that there are  multiple equilibria, and even the original ratex people knew this so it depends on some kind of coordination among agents on a focal point, with no clear mechanism for how this would be achieved.  The usual standard stories, usually only periodically told in an offhand manner amounted to either that it is the job of central banks to effectuate this selecting of the coordinated equilibrium, or somehow or other one of these outcomes indeed gets to be privileged over the others, the really true natural rate/NAIRU that everybody should know, if only those pesky macro policymakers would just leave things alone and keep inflation under control, screw any fiscal or other policy effort to reduce unemployment, doomed so clearly that in many seminar rooms anybody talking such things would be snickered about in corners of the "better" seminar rooms, tsk tsk.

Now we have since seen at two clear violations of this garbage, which I never accepted (along with many others such as Jamie Galbraith and Dean Baker). One was in the mid-90s when Yellen and Greenspan decided that good supply side conditions made it possible to continue lowering the fed funds rate even as the unemployment rate plummeted to the then "estimated natural rate."  Sure enough, instead of the dreaded NAIRU kicking in with an uptick in inflation, both inflation and unemployment continued to fall, the very opposite of the stagflationary 1970s. These people did sometimes note that one of the favorable supply side conditions holding in the late 90s was a very low oil price that stayed low., only starting to rise again after 2001.

The other is the more  obvious evidence for presence of unemployment hysteresis and no NAIRU whatsoever since 2008r. Highly stimulative monetary policy over a long time, publicly supported by Krugman and many others (zero bound and all that), but implemented by Bernanke and Yellen, to long and loud and howling by inflationistas.  Indeed, the December hike looks like those hysterical fools finally getting their say at the FOMC, even as the rate of inflation was continuing to decline even as employment was improving, curiously an effective assertion of a newly dominant Phillips Curve, even though we were supposed to have gotten over such silly things decades ago.

Going back to the 60s and 70s, even the original paper by Samuelson and Solow on the Phillips Curve, while they recommended taking it at least somewhat seriously in the short run, they had numerous caveats, which Samuelson would reproduce regularly in his Principles textbook.  So, when the oil price shocks hit after 1973 and we saw both inflation and unemployment rates rising, the actually existing stagflation that the Friedman-Phelps-Lucas gang would jump on to declare the end of the Phillips Curve and the triumph of those obviously rare times when wicked and ignorant policymakers would try to stimulate the economy and push unemployment below the natural rate/NAIRU, Samuelson and others would talk about the "Phillips Curve shifting outward" dud to the supply side conditions.  Baumol and Blinder soon introduced garden variety AS/AD analysis into their Principles textbooks to more directly take account of these bad things that can happen to your economy due to rising oil prices.  For quite a few editions, Samuelson held out with focusing on the Keynesian Cross and then bringing in a verbal story about how the rising oil prices would shift out the Phillips Curve, which clearly was sufficient to explaining the stagflation, even as new classicals saw the stagflation as somehow throwing Phillips Curves out the window except for when wicked policymakers tried to employment do better than the sacred natural rate, shame on them, tricking all those poor sucker agents not coordinating on the one true natural rate/NAIRU.

So that is the story, and I am sticking to it, and I think Blanchard basically agrees with it, which means that the  current situation where low oil prices mean low stock market prices and vice versa is simply insane.  It is only explicable by some herding speculative frenzy, because even though certainly oil producers/exporters suffer.  But long studies by such people like my friend Jim Hamilton have long since verified that there are more oil importers and consumers, so the benefits to them in real terms of lower oil prices way outweigh the damage to those producer/exporters (let us all now weep for Russia, Saudi Arabia, and Iran).

My own initial take on this dates back to 1969, when I wrote a senior honors undergrad thesis at the University of Wisconsin-Madison, titled,"A  History of Oil Price Changes in the Middle East."  I forecast that OPEC would gain market power in the future.  This then came to pass in 1973 oil price shock, triggered substantially by oil export quotas and production OPEC.  I later published on all this.

By the time of the second big oil price shock in 1979, which followed the fall of the Shah of Iran, which was followed by a reduction of oil production in Iran from 6 million barrels per day  to 600,000 (with the Saudis trying to offset that, but they could only increase their production by about 2 mbd, not enough do the trick, so the price of oil tripled in a short space of time, the second of the big "oil price shocks" that was followed by another surge of stagflation in the oil importing economies.

Following this I appeared on a few panels debating the sources of inflation.  Post Keynesians liked to allow for "cost-push" supply side inflation effects (see oil price shocks above), and given my past work I thought that looked pretty reasonable, but others on these panels where Chicago style Friedman monetarists, one an actual student of old Uncle Miltie himself, for whom all this was due excess monetary growth.  Could not have anything to do with a monopoly power induced oil price increase, because, hey, the price of oil is a mere relative micro price.  It cannot drive inflation, and any inflation that appears to be coming from it is really ultimately dues to bad monetary policymakers not following his steady growth of M rule (which would lie it tatters by the end of the 1980s).  But, hey, who is keeping track? (although before he died Friedman admitted his old rule no longer held and he advocated using interest rates to target inflation instead).

Getting more personal, this is my first blogpost since I had open heart surgery on Jan.  5.  I am at least partly back and trying to do professional things, but very weak and having to take two tylenols every four hours to keep the pain in my chest under control  I still need a lot of rest, and I have very low stamina and energy.  Nevertheless I am in much better than most people two and a half weeks after  they had open heart surgery (it was an aortic valve replacement).

Finally, and somewhat ironically I am writing this in my house in Harrisonburg, Virginia, where it has been snowing sin 10:45 AM as part of the Jonas winter storm, and we are the "bullseye" according to the Weather Channel.  Really.  Go look at  the channel and see where it is not only going to be more than two feet, but this morning I watched Jim Cantore (who is in Washington) ask the guy in Atlanta, "What is that while spot in the middle there?"  The answer was that it is the tiny spot where there maybe more than three feet.  They showed a white arrow pointing at what they called the "bullseye," and, yes, Harrisonburg, Virginia is smack dab center in it with the Weather Channel mentioning our location by name.

The only good side is that we shall not officially be in blizzard territory tomorrow afternoon, which is being forecast for Washington.  That needs a sufficiently high wind, and the mountain ridges surrounding the Shenandoah Valley will have those winds, but down here in the valley itself the mountains will protect us from the highest winds, and our high winds will  just fall short of putting us into the official blizzard category.  But we are likely to be at or very near the highest aggregate snowfall total off all for Jonas.

As it is, it is very pretty to watch, very heavily coming down now, although with the wind not bad yet.  And, yes, we about as well prepared as we can be all stocked up on everything, firewood by the fireplace in case the power goes out for a long time tomorrow afternoon.  My only regret is that due to my recent heart surgery I cannot help with the shoveling that most on our street are out doing trying to keep those totals from getting too bad before it is all over.

So, I wish all of you, my friends and others, all the best, especially if you are going to be affected by Jonas, but also all of you around the world wherever you are who are not going to be directly affected by  this snow.

Barkley Rosser


Anonymous said...

Some take low oil prices as an indicator of economic weakness - prices are low due to low demand, which will play out in poor GDP numbers. Low oil prices hurt oil producers and related companies.

Low oil prices also give consumers and businesses more money for other things.

So it's a balance between these two forces. The narrative I hear is that a bit lower prices help consumers, but much lower prices indicate the economy is seriously messed.

JDM said...

Nice to have you back.

kevin quinn said...

Barkley: Glad to see you back!


RGC said...

I had aortic valve replacement and was in pretty good shape after about 4 weeks. Here's hoping your recovery goes as well as mine.

Unknown said...

Take care, good to see you on the blog.

Sandwichman said...

Welcome back, Barkley.That was quick.

Myrtle Blackwood said...

Good to see you recovered enough to write again Barkley. Welcome back to the blog.

Re: "down here in the valley itself the mountains will protect us from the highest winds, and our high winds will just fall short of putting us into the official blizzard category. But we are likely to be at or very near the highest aggregate snowfall total off all for Jonas..."

I'm glad to hear that the valley will afford some protection for you. We are also protected a great deal from the south westerly winds by the valley formation our house is in. Fires are raging out of control across the Tasmanian state. Fed by a consistent 16 year long drying out and ever hotter temperatures here. Reinforcements for fire-fighting have come from interstate yesterday (about 14 days too late IMHO). Unfortunately the Tasmanian Fire Service have a policy of letting fires go until they show signs of getting out of control...!