Beware $90 oil

December 8, 2010: 12:34 PM ET

With high unemployment, weak consumer spending and falling home prices, what else could possibly slow America's economic recovery? Oil prices.

oil pricesThough prices have retreated a bit since, crude oil climbed above $90 a barrel on Tuesday – its highest level in two years. Futures rose by 1.5% to trade as high as $90.76 in New York, according to Bloomberg.

Why should we care? The development alone certainly won't pull the economy back into a recession, but it's an indicator to start watching closely, says James Hamilton, economist with the University of California in San Diego. Hamilton, who has done extensive research on oil shocks and business cycles, says the rise could put another damper on consumer spending and add to factors slowing the economic recovery.

He believes that the surge in oil prices, which surpassed $140 a barrel in the summer of 2008, helped send the economy into the Great Recession that started December 2007 and ended in June 2009. It's true that the housing and banking crisis played a major role, but so did oil shocks. The spike in prices hurt consumer spending, and especially the U.S. auto industry.

In his research, Hamilton looked at the impact of oil prices on the auto industry to economic growth. He found a clear decline as oil prices skyrocketed and estimated that if the auto industry hadn't shrunk, GDP growth would have been half a percentage point higher from mid-2007 onward.

Consumption overwhelming makes up the majority of GDP -- about 70%. With so many dicey variables teetering either way in today's economy, it's anyone's guess how this latest development could impact the consumer in the coming months.

The rally Tuesday came as President Obama and Republican leaders agreed to extend Bush-era tax cuts. Also, a cold snap through Europe and the U.S. lifted demand for fuel. But U.S. crude fell slightly to $87.93 a barrel Wednesday after U.S. government data showed inventories for refined products rose sharply last week.

So where will oil prices go in the coming months? Some analysts predict that the commodity will hit $100 a barrel sometime next year as demand rises from China and other emerging economies. But various factors might send prices down as well, as the spread of Europe's debt crisis could strengthen the U.S. dollar and send prices for the dollar-denominate commodity downward.

For now at least, the $90 price is right around the point where consumers start noticing higher oil prices at the gas pump, Hamilton says. And with noticeably more spending on fuel, this could be another factor tightening consumption -- a development that would almost certainly slow down the recovery further.

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About This Author
Nin-Hai Tseng
Nin-Hai Tseng
Writer, Fortune

Nin-Hai Tseng covers economics and finance. Before joining Fortune, Tseng was a reporter at The Orlando Sentinel and a public affairs associate at GE. She holds an MPA from Columbia University and a BS in Journalism from the University of Florida. She lives in New York City.

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