Some observers of the economy have questioned recently whether rising gasoline prices might be putting a pinch on consumer spending just as there are glimmers of hope that we may be nearing the bottom of our economic collapse.  At the same time, Congress is beginning to focus on health care reform, which represents about 16.2 percent of all spending in the economy ($2.24 trillion in a $13.8 trillion economy in 2007), a segment of the economy that has grown by nearly 65 percent since 2000.  Given that health care costs are even higher than energy costs, and that they too have risen sharply, why is it that no one ever suggests that rising health care costs will throw us into recession, as is commonly understood energy prices have done in the past.

There are probably two major factors at play.  First, health care costs have risen significantly and consistently over time.  In contrast, the cost of oil is highly volatile.  That means that families and businesses can plan for rising health care costs as they know that they are going to rise.  But it is much more difficult to predict the direction or magnitude of the change in oil prices over the next year, for instance.  That means that while we all expect health care expenditures to rise between five and ten percent each and every year, it is more difficult to plan for higher energy costs.

Second, short term demand for gasoline is more inelastic than oil.  If medical insurance premiums rise to high, people can choose to go uninsured.  On any given day if they are sick, they can choose to go, or not to go, to the doctor.  If someone is uninsured and very sick, one can go to the emergency room and generally receive at least some level of urgent care without making an immediate payment.  One may even be able to obtain low cost care or a deferred payment plan for their regular doctor.  This is not to suggest that our health care crisis is not serious.  In fact, high health care jobs probably make us less competitive as compared to manufacturers abroad, and are probably costing us American jobs.  It clearly wrecks havoc with household finances, with medical expenses being a major cause of personal bankruptcy.  Despite the havoc they can create, they typically are not thought of as contributing directly to the onset of recessions.

In sharp contrast, there is no such thing as emergency gasoline.  If you wake up with one gallon of gasoline in your tank and need two gallons to get to work, the Exxon station at the corner is unlikely to provide you with free emergency gasoline.  In other words, if you need gasoline, there is little choice but to pay for it – your demand for gasoline in the short term is nearly inelastic.  That has a direct effect on household discretionary spending, and effect that can spread throughout the economy.  It also can have an effect on the nature of household spending.  For instance, high gasoline prices led consumers away from SUVs that were profitable for the automakers but which yielded poor fuel economy, contributing to the automakers’ recent problems. 

In any event inelasticity of short term demand, its accompanying price volatility and their effect on the economy are a few of the key problems we face due to our dependence on oil.  So long as that dependence remains, so will our vulnerability to oil price volatility.

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