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Oil prices need to stay up Samuel Brittan Financial Times 24/02/06 If anything about the world economy could keep me awake at night, it would be neither the danger of another recession nor the alternative danger of fresh inflation arising from excess “liquidity”. It would be the possibility of a temporary fall in the price of oil. David Walton, of the Bank of England monetary policy committee, recently gave a lecture entitled: Has Oil Lost the Capacity to Shock? His main object was to explain why the current explosion in the oil price has had neither the inflationary nor the recessionary effect of previous shocks. One reason is that the price increase has taken longer to unfold. Mr Walton goes on to say that the UK has been better placed to absorb the current oil shock because of the absence of the excess demand which coincided with previous shocks. In addition, the labour market is now “more flexible” – real wages have been modestly squeezed to absorb higher energy prices without any attempt at catch-up. Last but not least, successful inflation targeting has “helped anchor inflation expectations”. This means that employers and unions have not projected into the future the initial impact of higher oil prices. I am happy to grant the MPC credit for the UK monetary framework. But I would like to turn to another aspect of Mr Walton’s paper. That is the chart at the beginning of the real sterling oil price. This rose to a peak during the first shock of 1973, then subsided in the later 1970s only to rise again during the second shock associated with the deposition of the Shah of Iran. There was a third sharp, but very short, shock at the time of the first Iraq war. In the light of what came before and after, the period between the mid-1980s and the beginning of the 21st century looks one of relative stability. The earlier shocks were, however, sufficient to reduce UK energy use from a peak of 3.5 per cent of gross domestic product in the early 1980s to 1.5 per cent in 2003. But the reduction nearly all took place between the 1970s and the mid-1980s. Something similar happened in the US when several administrations launched energy-saving drives, only to let the efforts fizzle out once the crisis was no longer staring them in the face. The latest oil price explosion has bitten deeply into business psychology. Yet we should be on our guard. A faltering in US and world growth could easily produce a temporary fall in oil prices which would again set back progress being made towards greater fuel efficiency. There are three reasons for wanting to economise on energy in general and oil in particular. First, there is climate change. In a recent address, Sir Nicholas Stern, who is conducting a British Treasury inquiry into the economics of global warming, listed a number of policies such as carbon-free electricity generation, which could reduce unhealthy emissions. All of them would be stimulated by high oil prices and most would be well worth achieving for their own sake. Second, there are old-fashioned environmental considerations. The ever-increasing emission of toxic substances into the atmosphere cannot be healthy; and it is noticeable that protagonists on all sides of the debate like to live in country areas as far removed from motorways and industrial works as possible. Third, George W. Bush, US president, is right to stress the need to reduce energy dependency on the Middle East and other volatile areas. In my book, it is the most important reason of all for energy saving. The obvious policy suggestion is if there is any pause or temporary setback in oil prices, the British government, for instance, should revert to its earlier policy of gradual increases in energy taxes; and maybe the US will move in that direction, driven mainly by the individual states of the union. There is the danger that members of the Organisation of the Petroleum Exporting Countries will try to pre-empt such moves by cutting supplies and raising market prices, thus collecting the economic rent for themselves. But Opec is only a partially successful cartel; and the issue of who gets the rent is of secondary importance compared with the need for a continued incentive to oil and energy saving.
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