Friday, June 3, 2011

Have Rising Energy Prices Hurt Retail Sales in Rhode Island?

By now, just about everyone is aware of how burdensome the ongoing increases in food and energy can be. Sadly, our pay doesn't keep pace with these rising costs, so on an inflation-adjusted basis, income is actually falling (economists refer to this as real income). The result of declining real income is that one particular area of spending, discretionary spending, is hit very hard. Why? Because discretionary spending, spending that one really doesn't have to do, but would like to do, is generally predicated on either having extra purchasing power (i.e., higher real income) or using credit. Home equity is largely gone as a basis for credit, and many people are either unable or unwilling to add to their credit card debt. So, spending patterns adjust and the extra boost that discretionary spending gives to the economy begins to dissipate.

A scary factoid I recently read about concerning this is particularly disturbing: according to Walmart, spending by their customers at the end of each month has been dropping very sharply of late. Apparently, many of their customers simply run out of money by month's end! I honestly don't recall seeing anything that drastic in a very long time, if ever. This is clearly a sign of the magnitude of the problems the US is facing.

What about Rhode Island? Is there any empirical evidence that retail sales here have been hurt by higher energy prices? Sadly, the answer is yes. To explore this, I converted retail sales into their inflation-adjusted (i.e., real) values. I then contrasted the rates of growth in real retail sales for Rhode Island with growth rates in gasoline prices. To make this less volatile and to make it easier to visualize the underlying relationship involved, all growth rates compare values in a given month to the same month one year ago (called year -over-year, denoted Y/Y). The chart below (click to enlarge) shows the results.

To put this into context, the economic impact of rising energy prices depends on both the levels to which they rise and how rapidly they increase. The more rapid is the rate of increase, the less able are persons to adjust to the changes they are confronted with. The rate of increase in gasoline prices is shown in the chart as a rising red line as of June 2010.

First, and foremost, the negative effects of rising gasoline prices are not instantaneous. Thank God! It takes time for rising gasoline prices to significantly erode real income and hence the ability of persons to purchase goods. Also, it must be kept in mind that gasoline prices are not the only factor affecting real retail sales. Other factors also matter (employment, hours, etc.) so there will not be anything resembling a perfect correlation in a chart like this.

The chart shows that after gasoline price growth fell to very low levels by mid-2010, they began a sustained period of accelerating growth through March of 2011. Economic activity in Rhode Island improved during the second and third quarters of 2010 (based on my Current Conditions Index), which helped to offset some of the building negative effects of the more-rapidly rising gasoline prices. Note that there was a jump in real retail sales growth during the 2010 holiday season, in spite of the fact that gasoline prices had been rising at more rapid rates for a while by that time. But once the 2010 holiday season ended, I think of this as the "last hurrah" for retailing here, things changed. While real retails sales were still rising, their growth began to slow as we entered 2011. Eventually, real retail sales declined (their growth became negative) driven in no small part by the period of accelerating increases in gasoline prices. Retail weakness, should it persist, does not bode well for future economic growth here, and it won't help us to sustain recent pleasant surprises in retail sales tax revenue.

Where do we go from here? Recall that both levels and rates of growth in gasoline prices matter. So, while the rates of increase in gasoline price have recently slowed, the result of moderating global growth and some firming of the US dollar, the level of gasoline price is still relatively high, close to $4 per gallon. Absent major declines in gasoline price this summer, this stubbornly high cost of gasoline will continue to take its toll on economic activity here.

Timing can be everything. As Rhode Island's economy has been growing more slowly of late (based on my Current Conditions Index), repairing the damage from high and rapidly rising gasoline prices will take time, so don't expect any snap back of the rate of growth here. That would be true even if we didn't have the negative effects of budget deficits and the pension crises to deal with.

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