A second reason is that, normally, a supply-driven oil price decline raises world demand by transferring resources from high-saving oil producers to consumers with a higher propensity to spend. This channel, however, has been muted, as major oil producers have faced pressures to increase spending, and as consumer countries continue to repair balance sheets from the financial crisis.
Third, the collapse in oil prices has led to a major short-term drop in investment in the oil industry, with global investment in production and exploration falling from $700 billion in 2014 to $550 billion in 2015, with spill-over to energy commodities. Sharp declines in investment in other commodity sectors have also contributed to overall slow global growth.
There is no question that the oil price decline has been a significant contributor to the financial market volatility of the past year. Can the impact worsen? A primary concern is the a cycle of deteriorating financing conditions for oil companies and oil exporters. Countries that are heavily dependent on remittances from citizens working in oil economies are also at risk. So far, exchange rate flexibility and (for some countries) a large cushion of hard currency reserves have helped in avoiding an outright financial crisis. But if the low price is sustained, important oil producers will become increasingly vulnerable if they are unable to make the requisite fiscal adjustments to a lower price trajectory. The recent episode underscores that over the longer term, it is important for oil exporters to diversify their economies and sources of fiscal revenue in order to decrease vulnerability to oil price volatility.
For oil-importing advanced economies, the price decrease is a welcome stimulus, and provides an opportunity to strengthen fiscal resilience against capital outflows for many emerging markets. It is a clear boon for Europe and Japan, albeit more mixed for the United States which is both a large consumer and a large producer. Regardless, it is important for policy-makers to continue policies that strengthen the long-term growth potential of their economies. Although futures prices suggest that oil prices will rise only moderately over the next four years (to just over $47 as of Feb 21, 2016), it is important to prepare for the fact that oil prices can rise in the future just as sharply and unexpectedly as they have fallen in the past.
*Author: Kenneth Rogoff, Professor of Economics and Public Policy, Harvard University. Kenneth Rogoff, professor of economics and public policy at Harvard University and recipient of the 2011 Deutsche Bank Prize in Financial Economics, was the chief economist of the International Monetary Fund from 2001 to 2003.
