Comment to Professor Nouriel Roubini on:

Effects of the Recent Oil Shock on the Global Economy in 2005-2006: How Much of a Global Slowdown?

CICLO DE CONFERÊNCIAS MEIPerspectivas da Economia Mundial

Miguel Lebre de FreitasGEE- Gabinete de Estudos e Estratégia

Real effects of the current oil shock not so significant so far:

- Real oil prices did not rise that much

- Sounder monetary policies

– Lower dependency

– Financial innovation

– Until now consumers have reacted to the oil shock as if it was a

temporary shock (when a shock to real income is temporary and

there are no liquidity constraints, it is optimal to maintain the

consumption level and reduce savings).

Risks to global stability However, the global situation is fragile

- Investment in most of Asia (taking out China) is too low, and high

consumption in the U.S. is financed by rapidly increasing debt, coupled

with high housing prices, while growth of domestic demand in Europe

and Japan is too weak.

- The persistency of high oil prices could trigger a global crises

Oil prices interact with the global business cycle:

– In the short run, oil demand and supply are inelastic, causing significant

price swings, namely in response to the global business cycle.

– OPEC countries are aware of this and usually try to adjust production

plans so as to not cause recessions in the West.

– The current situation, however, is of low spare capacity in oil producing

countries and low refinery capacity in oil consuming countries (Hog

Cycle).

Moreover, the demand for oil is expected to keep rising

Three Scenarios

1. BW2 (with Asia playing the role of Europe in BW1):

US economy financed by Asian banks, preventing the dollar depreciation and the interest rates from rising. In this scenario, exchange rate stability will fuel global growth. Oil prices will remain high. For how long?

2. Moderate slowdown in the US

As the inflation rate surges, the Fed rises the interest rates, leading to a flattening of the housing bubble. Consumers’ confidence and expenditures will fall and the US current account will improve. Oil prices fall back.

3. US and global hard landing

The (persistent) oil price shock triggers a consumption retrenchment, a bursting of the housing bubble, a deterioration of the US fiscal position and a massive flow of capital out of US.

To avoid the hard landing: – Coordination of macroeconomic policies would be desirable – But there are political difficulties. – Thus, the likelihood of an orderly global rebalance is low.

On the global prospects

With no question, there are some important and increasing risks:

– The widening of global imbalances:

– Higher and volatile oil prices, in a context of geo-political uncertainty

But:

– Global growth has been robust despite the oil prices

– Inflation has picked up slightly, but it remains at moderate levels.

– The global financial system is now much more resilient, with markets relatively stable.

– The recent move towards flex in Asia (namely China) is good news for the global imbalance.

Still:

The risk of a global recession is not ruled out

(IFM Managing Director, Mr. Rodrigo De Rato, 22 Sept:

“oil prices have become certainly a threat for the world economy”).

My question:

- If oil prices were indeed to stay high (optimistic scenario)

- The shock was of a permanent nature

- In the absence of significant investments aiming the

expansion of the existing energy producing capacity

- In the absence of effective efforts attain a greater

efficiency in energy use

- What would be the implications for a small, energy-

dependent and energy-inefficient country like Portugal?

Real price of Oil in Portugal (as of August 2005)

0,0

2,0

4,0

6,0

8,0

10,0

12,0

14,0

16,0

1953

1955

1957

1959

1961

1963

1965

1967

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

(Jan

-Jun

)

Ago

-05

0

10

20

30

40

50

60

70

Preço relativo do petróleo

Preço do Petróleo em US$

,

Source: GEE

Aggregate demand effects:

In the current circumstances, in which households are

somehow leveraged and interest rates are at historically

low levels, a dump in consumption expenditures

following a permanent rise in oil prices (and following the

corresponding ECB reaction) would be difficult to avoid.

Intensidade Energética

Consumo total de energia final (tep)/ PIB (milhares de dólares a preços e taxas de câmbio de 1995)

0,07

0,09

0,09

0,10

0,11

0,11

0,12

0,12

0,12

0,13

0,13

0,14

0,14

0,15

0,15

Dinamarca

Alemanha

Áustria

França

Irlanda

Itália

Reino Unido

Suécia

Holanda

Espanha

Bélgica

Grécia

Luxemburgo

Finlândia

Portugal

Asymmetric Incidence

Supply side effects:

- In general, since oil is an input to many goods, producers would

bear losses.

- The impact on output and unemployment will depend on real

wages: the shock will be smoother, the greater the ability of the

firms to pass the burden to consumers and the more flexible

nominal wages are, wherever the “pass through” is limited.

– In sectors in which final goods are price-elastic (tradables),

producers will take the hit.

– As profit margins and returns on capital fall, capital will move

away from energy-inefficient units to energy-efficient units

(Disciplinary device?).

– Adjustment costs: since factors do not move instantaneously

from one sector to the other, unemployment rates may bust,

propagating the business cycle.

Grau de intensidade energética por sector(Consumo de energia final/PIB Industrial)

1,19

0,51

0,42

0,32

0,19

0,12

0,09

0,03

0,34

0,58

0,19

1,05

0,86

0,50

0,10

0,14

0,04

0,70

0 0,2 0,4 0,6 0,8 1 1,2

Ferro e Aço

Metais não férricos

Minerais não metálicos

Químicos

Papel e pasta de papel

Bens de consumo (alimentação, tabaco)

Têxteis

Engenharia

Outros sectores

Portugal

UE 15

Asymmetric Incidence

Autonomia Energética

Produção própria/ Consumo total de energia primária (2001)

1,37

1,12

0,78

0,67

0,500,45

0,38 0,35 0,320,26 0,22

0,15 0,14 0,120,02

Din

am

arc

a

Re

ino

Uni

do

Ho

land

a

Su

écia

Fra

nça

Fin

lând

ia

Ale

man

ha

Gré

cia

Áu

stri

a

Esp

anh

a

Bé

lgic

a

Itália

Po

rtu

gal

Irla

nda

Luxe

mb

urgo

Asymmetric Incidence

Current Account Adjustment :

In a energy-dependent economy, an oil price shock acts as a transfer to

oil producing countries abroad.

– In the short run, a current account deficit will emerge.

– If the shock is permanent, as external liabilities accumulate, capital inflows will become more difficult to sustain, calling for a real exchange rate depreciation

– In the past, this was achieved by nominal exchange rate depreciation (1974-1985). The fall in oil prices in 1986, in turn, was followed by a real appreciation.

– In the present circumstances, no such mechanism exist.

– Moreover, low efficiency in energy use is constraining the competitiveness of exporting firms and hence, the ability of the domestic supply to switch from nontradables to tradables.

In sum, in a theoretical scenario of a permanent oil shock, with no new investments in alternative energy sources and without an effective move towards energy-saving technologies, the optimistic scenario could be quite painful to Portugal.