Rocketing Gas Prices Hurt Consumers

It makes sense that higher gas prices will eat into consumers wallets, hurting consumer spending and economic growth. However, it’s not immediately obvious how much. Here, academics have studied the historical impact and it appears likely to be material if the current surge in energy prices is sustained.

Broadly speaking the current picture suggests that consumers may have to cut back spending on other goods and services by 3% to cover rising energy costs.

The Study

Michael Gelman at the University of Michigan and colleagues from Berkeley and elsewhere examined the one of the last major move in prices at the pump. This was actually in a different direction, a big drop in gas prices in 2014. They used machine learning against detailed consumer spending data to work out the impact. The National Bureau of Economic Research paper is titled ‘The Response of Consumer Spending to Changes in Gasoline Prices’. Of course, there findings for when gas prices fall, also help us understand what may happen as prices shoot up.

The Impact Of High Gasoline Prices

Predictably it’s not good news for the current state of the U.S. economy. Any move in gas prices tends to have a direct impact on household budgets. Yes, consumers do pull back on gasoline spending when prices rise. Maybe there are fewer road trips, more carpooling and more working from home in the current environment.

However, ultimately a dollar spent on gasoline is a direct substitute for a dollar spent elsewhere for a typical household. That means that the rise we’re seeing in prices at the pump may see a direct and almost one-for-one impact on spending elsewhere.

How Much Of An Impact?

Spending on transportation in the U.S. is volatile for two main reasons, making the impact harder to assess. Firstly travel spending obviously dropped off materially during the pandemic. It’s rebounding but Consumer Expenditure data hasn’t fully caught up with that yet. Secondly, of course, spending on gasoline depends to a significant extent on how much gas costs. Nonetheless, according to BLS Consumer Expenditure data in round numbers the average U.S. household spends a little over $60,000 a year of which about $2,000 is on gasoline looking at pre-pandemic data.

A Doubling of Prices

So gasoline spending is about 3% of the household budget. But that was when retail gasoline prices were around $2 dollars a gallon, now prices are over $4 dollars on the latest AAA numbers, with prices higher on the west coast, Alaska and Hawaii and lower in more central states.

Decreased Spending Elsewhere

That suggests that if gas prices have doubled, they are now likely to make up around 6% of consumer spending, up from 3% previously. The research suggests that spending on gas is likely to cause a corresponding drop in spending elsewhere in household budgets working out to approximately be a 3% reduction. That’s a pretty material shift. Of course, the run up in prices has been swift and oil prices remain volatile, so ultimately the impact will depend on how gasoline prices trend over the coming months. Nonetheless, consumers are likely to see a material shift in their spending of about 3% of their budget from other goods and services to gasoline if the situation holds.