Can High Oil Prices Be Good?

World oil prices crossed $40 a barrel in mid-summer, and have since climbed to the mid-$50's. Today's oil prices are still only two-thirds the real peak reached during the Iranian Revolution of 1979, and future markets expect the oil price to fall back and settle at perhaps $45 a barrel. But the current high level of oil prices has led forecasters to start reining in their expectations for economic growth.

"Higher oil prices are here to stay," says the American economic forecaster Allen Sinai. "[T]hat has to subtract growth and could cause core inflation to pick up." Indeed, according to Sinai, higher oil prices are "the biggest risk...since the bursting of the stock-market bubble in 2000-2001."

Sinai is hardly alone. If the oil price stays at $40 a barrel, expect it to have next to no effect on short-term world GDP growth. But if the oil price remains at or near $60 a barrel, expect everyone's forecasts of GDP growth to be reduced by 1% per year.

High oil prices also threaten to slow long-term productivity growth. With high - and volatile - oil prices, businesses will focus their investments less on boosting productivity and more on maintaining flexible energy usage. At $40 a barrel, expect oil prices to slow the long-run growth rate of the world's potential output by 0.1% per year. At $60 a barrel, expect the "measured" long-term rate of potential world output growth to slow by roughly 0.3% per year.