Cheap gas and U.S. GDP growth: they go to together like Simon & Garfunkel

By Money Matters Editors

Right now, average U.S. gasoline prices are at an inflection point: move any higher and there’s real trouble up ahead for the U.S. economy.

Conversely, a drop from current levels – about $2.63 per gallon for unleaded regular – and the U.S. economic recovery could get a tail wind.

Here’s the bleaker scenario: something happens to Americans as they see the price of gas top $3 per gallon. (It’s already above $3 for super unleaded in higher-costs areas like Los Angeles, New York, and San Francisco.) Americans cut back discretionary purchases in order to be able to fill their gas tanks with the gas they need, without breaking their budget. And that cutback in discretionary purchases shaves growth off  U.S. GDP.  Further, if the price remains over $3, it also convinces more Americans to choose a more fuel-efficient vehicle. And we know the impact higher gasoline and diesel prices have across the U.S. economy: it increases costs at just about every stage of production.

Here’s the brighter scenario: if oil falls from its weak-dollar-boosted level, and gasoline drops to $2.40 or $2.20 per gallon, there will be a disposable income effect. Americans will continue to make those discretionary purchases, and these transactions, combined with an improved consumer psychology that historically accompanies relatively low gas prices, will help increase U.S. GDP.

Here’s one example: As a result of having to spend $100 more per month on gasoline due to high prices, a Dad and Mom in suburban Kansas City, Missouri decide they can’t buy their daughter that new desk top computer that she needs for her sophomore year at college. Conversely, gas prices drop, and the Missouri parents make the purchase and buy the $900 computer. Now add that effect up over millions of households. You can see how energy costs affect economic growth in the United States.

So, for a clue to how the U.S. economic recovery is faring, keep an eye on gasoline prices.