On Thursday, March 17, James Hamilton joined Markus’ Academy for a lecture on Sanctions, Energy Prices and the Global Economy. Hamilton is the Robert F. Engle Professor of Economics at the University of California at San Diego.
[1:00:29] Sanctions in Russia, additional questions.
[0:00] Introductory Remarks: The Russian invasion into Ukraine might mark a watershed moment in the global economic order. Before the invasion, we hoped that mutual interdependence as it makes war expensive and hence ensures peace; trade leads to interactions and international finance makes us more interdependent. After the invasion, the world has changed. We now focus on resilience, self-reliance and autarky. We might be looking at the possibility of “slowbalization”, the end of the peace dividend. Focusing on the effects of sanctions; the technical elasticity of substitution between different sources of energy might not be enough, as non-linear effects, e.g. due to financial frictions might kick in. Haussmann suggests a long-run “tax sanction,” which could be credible, and because of the high elasticity of demand compared to supply, the burden of this tax would fall on Russia. Subsidies to energy consumption may actually help Russia, so a lump-sum subsidy could be better. Sanctions may threaten the inflation anchor further.
[13:10] Global and U.S. usage of crude oil and natural gas. Stopping trade is incredibly costly for everyone. Oil prices increased before the invasion because oil demand recovered faster than oil production, demand nearly back to pre-pandemic levels. U.S. production has not recovered, though the number of drilling rigs is going up, and production is expected to continue to get back up. Russia produces 13% of global crude oil and 17% of world natural gas. Oil trades on a world market. Because of this, the tax burden from any tax on crude oil that is only implemented in some countries would fall onto consumers in that country. Natural gas is much more localized, and cannot be transported as easily, so in terms of natural gas, the most affected areas are Europe and Russia.
[26:01] Possibility of a recession? Because refined petroleum is about 4% of GDP, quick calculations would suggest that losing all Russian oil production would be about 0.5% of GDP, much less than the average decline in U.S. GDP in recessions. Energy’s share of GDP has been declining over time, but because the short-run demand is relatively inelastic, any increase in prices means that the share increases. In Germany, Bachmann et al. (2022) argue that a cut-off of Russian energy imports would reduce GDP by 0.5-3%, depending on substitutability. Supply disruptions between 1973 and 1990 show us that 5% supply cuts – a figure smaller than the 13% of oil plus 17% of natural gas supply from Russia – often cause global recessions with an underutilization of other resources as well. For example, auto production decreases as oil prices spike. In general, a recession is probably unlikely, but if there is a drop in shipments of oil and gas, there could be a big problem, especially in Europe.
[41:05] Effect on consumers. Median households spend only 4% of income on gasoline, but it has a larger impact on overall expenditures because consumers become pessimistic as oil prices rise. An energy price increase has the potential to disrupt spending on other goods, and in the presence of nominal rigidities, this could contribute to a drop in real GDP. There could also be GDP drop because of the barriers to reallocating productive resources in the short run.
[44:03] Could this affect inflation? If the price of energy increases while other prices decrease, the shock need not be inflationary. However, if other prices are inflexible downwards, a relative price increase will be inflationary. Quick calculations, consistent with a rule-of-thumb mentioned by Fed Chair Jerome Powell, would suggest that the contribution to inflation from this mechanical effect could be calculated by multiplying the percentage change in crude oil prices by 0.02. The oil itself is making a contribution to output and inflation shifts, but it is the other mechanisms like rigidities that magnify the effects. Many countries see a GDP hit when there is an oil shock, but the exact pattern differs. Supply problems are likely to get worse before they get better.
[52:30] Global implications. Higher oil prices also have implications to emerging economies. Importantly, higher oil prices benefit oil exporters (like Brazil) only temporarily and they suffer in the intermediate and long-run from higher oil prices as global economic growth declines.
[1:00:29] Sanctions in Russia. The non-oil sanctions and measures taken already are already a very big deal. Not being able to use many different forms of banking affects consumers and firms, and banks suffer without being able to use SWIFT and Fed/ECB clearing. This will have a lasting impact.