Pain at the pump: What spiking gas prices mean for consumers, the US economy

It’s not always easy to see how economic policies are intertwined. 

But ever since four scholars at the Stanford Institute for Economic Policy Research (SIEPR) calculated that the spike in gas prices from the U.S.-Israeli war on Iran threatens to wipe out tax refunds many Americans are expecting this year, their research has been causing a stir in the media and in policy circles. Here two of the authors — Neale Mahoney, the Trione Director at SIEPR and the TG Wijaya Professor of Economics at Stanford, and Ryan Cummings, SIEPR’s chief of staff — talk about why The Wall Street Journal, The New York Times, and many others are paying such close attention to their findings and what may be in store for consumers and the U.S. economy.

Why are rising gas prices such a big concern?

There are three reasons. First, gas is one of the least discretionary items in the household budget. You can put off a vacation or buying a new TV. You can't put off driving to work. Second, rising gas prices are regressive — gas is a larger share of the budget for lower-income households, so rising prices hit those with the least room in their budgets the hardest. Third, there is the macro dimension. Gas prices are perhaps the most noticeable price in the economy — we see them on large signs every time we get in a car. That salience gives gas price spikes an outsized effect on inflation expectations, which can compel the Federal Reserve to slow or even reverse interest rate cuts, with knock-on effects for borrowers and the investments our economy needs to keep growing.

Your recent analysis of the fallout from surging gas prices is drawing a lot of attention. Why?

We projected how much more households will pay for gas this year due to the oil price shock from the war in Iran — notably the closing of the Strait of Hormuz, which typically handles shipments of one-fifth of the world’s crude oil. Specifically, we estimated a model of pass-through from global oil prices to pump prices based on historical data to capture the famous "rockets and feathers" phenomenon, where gas prices shoot up quickly when oil prices rise but float down slowly after they fall.

We ran that model using Goldman Sachs' forecast from before the Strait of Hormuz closure and their most recent estimate, which assumes the Strait will have only limited traffic through April 10th. Under the latest forecast, we project gas prices will peak at over $4.25 per gallon in May, and that the average household will pay $857 more for gasoline over the rest of the year. The broader takeaway is that even once the Strait reopens and crude prices begin to normalize, consumers are likely to be paying more at the pump for weeks or months longer — the rockets go up fast, but the feathers come down slowly.

What are the likely economic and political repercussions of the Iran war’s energy shock, both near- and long-term?

The increase in gas prices is the most immediate and noticeable impact of the Strait of Hormuz closure, but it’s only the beginning. Airline ticket prices are rising sharply — jet fuel accounts for roughly 30 percent of airlines' operating costs in normal times and has surged approximately 75 percent since the start of the war. Prices at the grocery store will be going up as well, first as rising diesel prices increase the cost of the tractors, trains and trucks that move food from the field to the grocery aisle, and then again as the fertilizer price shock works its way through the agricultural supply chain.

We shouldn't ignore the flip side of the coin. The U.S. is a net exporter of energy, and for the oil and natural gas industry, rising prices are good for business. They'll also benefit the budgets of states with a large energy-extraction presence and will have spillover effects on the economies of those states.

Politically, rising prices undermine the White House's efforts to shift its focus to affordability ahead of the midterm elections. At the start of the year, the administration rolled out policies that suggested a pivot toward cost-of-living issues. But with gas prices dominating the headlines and food prices set to increase, the White House faces an uphill battle convincing voters to trust it on pocketbook issues.

What are the policy choices for bringing down gas prices?

The blunt answer is that, short of reopening the Strait of Hormuz, there is not much that can be done. Moreover, opening the Strait won’t fix things overnight. It takes time to ramp up production of oil fields and refineries, and that’s not to mention the time needed to repair and rebuild facilities that were damaged by Iranian missiles and drones. 

Releasing some of U.S. emergency reserves of crude oil won’t do much. Past Strategic Petroleum Reserve releases lowered pump prices only by an estimated 13-31 cents per gallon. Easing sanctions on some Iranian and Russian oil shipments and letting foreign ships move fuel between U.S. ports could help with short‑term distribution problems, but they wouldn’t fix the bigger issue of tight oil supplies globally. Another step would be to increase production of E15 gasoline (15% ethanol), but that, too, would help only a little because ethanol has less energy per gallon. Policymakers could also suspend taxes on gas, but that would strain government budgets already under pressure. Finally, boosting domestic production would take too long to make a difference anytime soon. 

Will this cause the economy to tip into a recession?

It’s a good question. Some readers may recall that in the 1970s, oil shocks stemming from the creation of the OPEC cartel caused the economy to shrink. This time around, however, forecasters think that even a prolonged closure of the Strait of Hormuz will not bring about an economic contraction. One reason is that the U.S. is relatively less dependent on oil than it was during that period — today, oil price shocks are more a story about winners (oil majors and states with high oil and refining production) and losers (consumers and industries that depend on fossil fuels). That said, it certainly doesn't help. Most economic forecasters predict that the Iran war's energy shock will add about 0.25 percentage points to core inflation and drag down GDP growth by roughly the same amount.

In addition to Mahoney and Cummings, the authors of the gas price analysis are Jared Bernstein, a Distinguished Policy Fellow at SIEPR, and Caleb Brobst, a predoctoral research fellow at SIEPR.