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What the Oil Price Drop Means for the Global Economy

The recent oil price drop has wreaked havoc with oil sector companies. But what is the wider impact on the global economy and the consumer?

Holly Cook 18.12.2014 | 10:32

 

 
 

Holly Cook: Hello and welcome to Morningstar. The recent oil price drop has wreaked havoc with oil sector companies. But we are going to look today at the wider impact on the economy and also on the consumer. Joining me to do that is Jose Garcia Zarate, he's a senior analyst and economist here at Morningstar. Jose, thanks for joining me.

Jose Garcia Zarate: Hello.

Cook: So oil prices are actually down 40% near a five-year low right now and that’s been playing havoc with the stock markets. But what impact does it have on those economies that rely on oil?

Zarate: Well there are a number of economies around the world which heavily depend on oil prices in order to keep their domestic budgets in check. We're talking about the likes of Russia for example, Ecuador in Latin America, Venezuela, but also Norway. Obviously the drop in oil prices is very damaging for their domestic prospects and it is estimated for some of these economies in order to have a balanced budget they need an oil price at around $100 per barrel. We are already at $60 and the predictions are that it might actually fall further. So you can actually infer that this is not going to be good times for these economies and they may have some domestic problems going forward.

Cook: So these economies that we are talking about, are those problems that they are facing as a result of oil price drop going to have a large impact on the global economy as a whole?

Zarate: Well, I mean there is obviously an impact for the global economy and actually there could be a positive impact and there could be a negative impact. Obviously the most obvious impact is that prices of energy, international energy and so on are going to drop and that should be reflected in inflation metrics for countries around the world. And that would be okay, if we were in a normal inflationary environment.

The problem is that we are not in a normal inflationary environment, in fact in some areas of the world we are grappling with deflation risks and that may actually make the task of the central banks much more difficult. And in fact I mean you should expect that perhaps expectations of interest rates hikes might be actually delayed. Because inflation is going to be lower than expected. And of course then there is the ongoing issue of debt. A very low inflationary environment makes it more difficult to grapple or deal with the stock of public and private debt.

Cook: But presumably it also means that for consumers they are paying less on fuel, for example, and energy costs so they’ve actually got more money in their pockets.

Zarate: Absolutely, I mean there is always a pro and there is always a con. And the pro is that for economies like the UK and the eurozone, where consumers have been struggling because wage growth has not kept up with very low inflation, so you can imagine that wage growth has been really non-existent, they are in a position now to catch up and actually recover some of the lost purchasing power. So over the long term, medium to long term you would expect that, that would be beneficial in terms of GDP output. Because consumers would be more willing to spend because they would feel that they are recovering some of the lost purchasing power. Not necessarily because wages are increasing, but because prices are actually falling.

The danger is of course we always end up with this debate about deflation and sustained deflation and this and that, and whether that could be a problem in the long term. But at the moment I think that’s why stock markets are in a bit of a volatile state, because they are trying to understand whether the pros or the cons are going to be the driving factor in the end.

Cook: Well, Jose thanks very much for helping us understand those pros and cons here.

Zarate: Thank you very much.

Cook: For Morningstar I'm Holly Cook. Thanks for watching. 

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Holly Cook

Holly Cook  is Manager, Morningstar EMEA Websites