Sunday, April 27, 2008

Does a President Control the Oil Price? A reply to BCBR

In Boulder County Business Report blog, David Clucas says

So who do we "thank" for the higher oil prices that ultimately fueled the green movement into fifth gear? I think we should thank Bush.

The president got us into a nasty Middle East war in the heart of world's source for oil. That's spooked the region, but fueled investors who ultimately control the price of the commodity. The President also is politically friendly to the oil industry, helping comfort those investors. As real estate and the financial investments collapse, more investors have flocked toward oil as a "safe" investment, driving the price further up.
It is editorializing, bordering on ad hominem attack, to attribute the results of market forces to one president. David further disagrees with increased demand from China and India and goes on to predict $65 oil per barrel when a Democrat takes over as the president.

If you do not think the current oil shock is due to increased demand from India and China, Krugman (in his NYTimes blog) points us to look for the inventory buildup. He asks where is the inventory due to a speculative run? Any significant drop in oil prices like the one David predicts will increase the demand considerably, driving the prices higher again.

What is the other reason contributing to higher prices in US? The weak dollar. That can be attributed to both lax monetary policy and a bad fiscal policy (tax credit and war spending). The increase in interest rate due to the above leads to weakening dollar which makes the oil imports more expensive. But a weak dollar also helps increase net exports.

I do not think any one President can do so much damage or so much of improvement like $119 to $65 oil. For his claim to be true, not only should all the hoarded supplies be released but also the dollar has to strengthen considerably from its current levels. The latter would increase our imports and hence shrink the national income.

The market forces are driving the oil prices. Higher oil prices are here to stay.

David does have a point on linking Oil prices and Green movement. Professor Mankiw calls this the Pigouvian tax. I will discuss this in another article.

Other article of interest: McCain's Gas Tax Vacation
Economist Nordhaus explains the effect of Oil shocks on the economy, in his paper, "Who's afraid of the Big Bad Oil Shock?"

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