3Qs: Do low gas prices hurt the economy?

The average price for a gallon of gas in the U.S. reached a seven-year low on Monday, according to AAA, dipping to $1.83. And the price of oil is the lowest it has been in more than a decade, with little hope for rebounding in the near future. born_125According to a report released on Tuesday by the World Bank, oil prices are expected to decline another 27 percent in 2016 after dropping by 47 percent last year.

Here, oil and gas expert Jeffrey Born, professor of finance in the D’Amore-McKim School of Business, explains why falling gas prices might be good for your wallet but bad for the economy.

First of all, why is the price of oil declining?

The decline in oil over the past few months is primarily due to three factors: 1) The Saudis—and others in OPEC—have been selling into a soft market in order to cause the price to go down, so that their oil could win back energy markets that were being taken by “cheap” natural gas being produced here in the U.S. 2) The demand for energy has been relatively weak because of the slowing economy in China and the slow growth in many parts of the Euro-zone. 3) The Saudis—and others in OPEC—have been trying to hurt the governments of Iran and Iraq over a political/religious conflict that escalated beyond rhetoric in January.

How do low oil prices impact states with prominent oil drilling industries, like Alaska, Wyoming, and North Dakota, and what kind of ripple effect can cheap oil have on statewide budgets?

During the natural gas “fracking” boom, the economies of the northern plains boomed due to drilling and energy production activities. Unemployment was very low and state governments enjoyed very healthy increases in taxes. These same states started feeling the pinch of falling oil prices and drilling activity declines more than six months ago, causing many to begin cutting their budgets and dipping into rainy-day funds.

Americans saved $115 billion on gas in 2015 compared to 2014, according to AAA, but they haven’t responded to the de facto tax cut by spending the extra money and helping the economy grow. Why aren’t consumers splurging with their gas savings?

Consumers pocketed much of their gasoline savings for some of the same reasons that corporations are sitting on record amounts of cash. In my opinion, many consumers—and corporations—are not confident that the economy will continue to improve. Through the Internet and social media, many are much more aware of the dismal and slowing economic activity worldwide than they would have been 20 years ago. This is contributing to consumer timidity here in the U.S.