5 Things That Change When Gas Prices Spike

Consumers typically spend less on other things--but the usual patterns may not apply this time around.


We all know how lousy it feels to pump $50 worth of gas into your car, when it used to cost $40 or even $30. It's an acute metaphor for falling behind, rather than getting ahead.

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That's obviously a big worry today, as average gas prices get close to the key threshold of $4 per gallon. With a long-awaited economic recovery finally starting to take root, some economists fear that rising gas prices could damage fragile consumer psyches and hamstring family budgets enough to stall growth for the third time in three years.

But rising gas prices affect the economy in a lot of ways that aren't immediately obvious. Some of them can even be positive in the long run. Economists have been studying gas-price shocks for decades, from the gas lines of the 1970s to the still-hard-to-explain surge in oil prices in 2008 that pushed U.S. pump prices over $4 for the first time ever. Here's what tends to happen every time gas prices rise, with some handicapping about how these forces might affect the economy in 2012:

Consumer spending falls. A 20 percent increase in gas prices—which is about what we've seen so far this year—means that spending on other things needs to fall by about 1 percent. That's because motor fuel accounts for about 5 percent of the typical consumer's spending, and most people have little choice but to pay the extra money when gas prices rise. So if spending on gas rises to 6 percent of the typical budget, spending on everything else must fall from 95 percent to 94 percent, more or less.

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Some shoppers cut back on small things, like snacks and drinks they might otherwise buy at the gas station, where the impact of higher gas prices is felt immediately. But for the most part, people put off big purchases like appliances or a new car, which are usually easy to delay for a while. Some people may also delay or cancel vacations, since that's something that's nice to have but not essential. "The big effects on the economy come not from buying fewer soft drinks but from these bigger shocks," says James Hamilton, an economics professor at the University of California, San Diego, who has done extensive research on gas price shocks.

This year, however, consumers are getting a break from a warm winter and falling prices for natural gas, which have lowered overall energy costs. That could change if it's an unusually hot summer and cooling bills skyrocket, but for now, many Americans are able to maintain their spending on other things because rising gasoline costs are being offset by savings elsewhere.

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Car shoppers buy fewer domestic cars and more imports. That's what happened in 2008, when the domestic automakers had few fuel-efficient models to offer but Toyota and Honda sold out of hybrids other gas-sippers. This, too, is moderating, however, since Detroit learned its lesson in 2008 and got serious about building small cars that could compete with the best from Japan and Europe.

General Motors, Ford, and Chrysler still fare best when sales of trucks and SUVs are strong, but new small cars such as Ford's Focus and Fiesta and Chevrolet's Cruze and Spark have captured many buyers who otherwise would have bought imports. Detroit's market share has still fallen a bit recently, as gas prices have risen, but that could be due to other factors, such as the recovery of the Japanese automakers after last year's tsunami knocked them offline.

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Automakers spend less. This is one way that rising gas prices can have a negative multiplier effect on the broader economy. In the past, as consumers cut back on durable goods purchases—and on domestic automobiles in particular—that forced U.S. automakers to cut back their own spending and lay off some of their workers. Hamilton says that this ripple effect can turn a 1 percent cutback in consumer spending into a 2 percent drop in overall spending, when business activity is taken into account.

But again, this doesn't seem likely in 2012 unless gas prices go a lot higher. That's partly because auto sales were so low over recent years that pent-up demand is driving them higher, even with the increase in gas prices we've seen so far. Some forecasters expect sales of nearly 15 million cars this year in the United States, which would be a healthy improvement over 2011 sales of 12.8 million, and a huge gain from the low point of 10.4 million cars sold in 2009. It also helps that industry-wide restructuring has reduced capacity and significantly lowered the break-even point for the Detroit 3, which allows them to operate at a profit and avoid painful cost-cutting, even when sales slip.

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Confidence suffers. Research by forecasting firm IHS Global Insight shows that every 10 percent increase in gas prices lowers consumer confidence by about 1.5 percent, with the depressive effect more than doubled when prices crest a round number such as $4, which intensifies media exposure and gets people's attention even more.

Rising gas prices also make consumers think that future inflation is likely to be worse than it might otherwise be, another reason they become gloomy and rein in spending. That's not always rational, because people tend to take less notice of things that are getting less expensive and easing the strains on their budget, such as anything with a microprocessor. But rational or not, the psychological effect of costly gas can be powerful.

Consumers adjust. Changes in consumer behavior can take the sting out of rising gas prices and help keep confidence buoyant. People try to drive less when gas costs more, but the bigger effects are the ones that occur over longer periods of time, such as buying a more efficient car or moving to reduce the expense of commuting. Americans are still adjusting to the price shock of 2008, for example, by purchasing smaller cars as it comes time to trade in their old wheels, and changing the way they budget for energy costs. New rules mandating higher mileage help: The average mileage of a new car has risen from 20 MPG at the beginning of 2008 to about 23 MPG today, according to TrueCar.com. It will probably keep rising, as car buyers continue to downshift.

That's why the prospect of $4 gas today is less frightening than it was four years ago. "It's not that people are happy with $4 gas," says Hamilton. It's that they've already figured out what they would do with those kinds of prices." If prices hit $5, of course, consumers would freak out anew. But over time, they'd learn how to adjust to that, too.

Rick Newman is the author of Rebounders: How Winners Pivot From Setback to Success, to be published in May. Follow him on Twitter: @rickjnewman