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Falling oil prices ‘like a tax cut’ for economy

WASHINGTON (MarketWatch) — Christmas has come early for the vast majority of Americans whose paychecks are barely rising: a temporary tax cut of sorts in the form of plunging gasoline prices.

The surprisingly large drop in the price of oil since midsummer is a boon for most consumers and U.S. businesses. Economists calculate that households have already saved about $100 billion so far, a windfall that could help produce the best holiday shopping season since the Great Recession and add several ticks to U.S. growth in upcoming quarters.

The bonus savings from lower fuel costs could also act as an insurance policy for the improving U.S. economy. Global growth has taken a turn for the worse to pose a threat to the domestic recovery, while the Republican takeover of Congress could trigger more political battles with a Democratic-controlled White House that muddles the nation’s economic outlook.

“It’s really like a temporary tax cut.”George Mokrzan, Huntington Bank

Cheaper gasoline is not entirely a good thing. Falling prices, for, example, stem in large part from slumping economies in Europe and Japan and a slowdown in the rising Asian giant China. Persistent weakness overseas would eventually dampen U.S. exports and act as a drag on an American economy that’s more reliant on global trade than ever before. The U.S. is no longer an oasis that can easily prosper in an economic desert.

The other main factor fueling the plunge in petroleum is soaring U.S. production, which could make the domestic energy industry a victim of its own success.

Energy producers have hired tens of thousands of people and spent large sums to deploy new techniques such as fracking to tap previously inaccessible oil in places like North Dakota, creating arguably the most dynamic industry in the United States. Hiring and investment could slow dramatically if prices continue to fall and remain depressed for an extended period.

“Any movement in energy prices creates winners and losers,” noted Robert Dye, chief economist at Dallas-based Comerica Bank and a longtime industry expert.

Still, the upside of lower gasoline costs to the U.S. economy easily exceed the downside, Dye and other economists stress. Airlines can cut fares, shippers such as UPS can lower rates, retailers can offer cheaper prices or delivery options — the benefits go on and on. And all of those factors could make the 2014 holiday season the best since the recession ended more than five years ago.

“Lower oil prices are a clear net plus because we are bigger consumers than producers,” said Michael Moran, chief economist at Daiwa Capital Markets.

After the fall

The decline in oil prices began in mid-June and it accelerated during the fall. The price of benchmark West Texas crude, for example, has tumbled 28% to $75 a barrel as of Wednesday from $103.66 five months ago. That’s the lowest price in four years.

Less spending at the pump to boost holiday spending, GDP

The result: filling up at the gas pump has fallen 22% nationally. A gallon of regular gas now costs an average of $2.89, down from $3.70 in June, according to the U.S. Energy Information Administration.

In many parts of the U.S., prices have declined even further to as low as $2.50 a gallon. And prices might go even lower.

For a family with two cars, the savings can average $50 to $75 a month. What’s more, some 8 million U.S. households, mostly in the Northeast, still rely on oil to heat their homes. They’ll save even more.

By and large, economists believe the money saved will be used to buy other goods and services, especially among the millions of families that typically spend most of what they earn each week just to get by. That’s generally been the case in the past, and with the U.S. savings rate already at a two-year high of 5.6%, households may be less inclined to sock the money away.

“If you have an extra $10 in your wallet, you are probably going to spend it,” Dye said.

Spending less on gasoline and more on other things is not a wash, either. Consumers feel better about the economy when gas prices are low and a higher level of confidence boosts the economy in other ways. Not surprisingly, consumer confidence recently hit a seven-year high in one survey and an eight-year peak in another.

Higher confidence is already showing up in the spending patterns of consumers.Americans are eating out more, for instance, and surveys indicate they plan to boost holiday purchases well above 2013 levels. That’s already spurring in increase in employment in the retail and hospitality sectors.

Lower fuel prices also tamp down inflation throughout the economy and increase inflation-adjusted incomes. So a worker who gets a meager 2% raise each year benefits if the annual rate of inflation falls from, say, 1.5% to 1%.

“It’s really like a temporary tax cut,” said George Mokrzan, senior economist at Huntington National Bank in Ohio. “That money goes entirely into the pocket of consumers.”

Just how much will that help U.S. growth? Analysts point out that a more energy efficient U.S. uses less gasoline than in the past and that fuel costs play a smaller role in the economy.

Still, they estimate gross domestic product could get a boost of perhaps several ticks from a prolonged period of lower gas prices. An economy growing 2.75%, for instance, might expand at a 3% pace if fuel costs remain depressed.

“It definitely leads to faster growth overall,” said Moran of Daiwa.


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