We explore the effect on U.S. real GDP growth of the sharp decline in the global price of crude oil and hence in the U.S. price of gasoline after June 2014. Our analysis suggests that this decline produced a stimulus of about 0.7 percentage points of real GDP growth by raising private real consumption and an additional stimulus of 0.04 percentage points reflecting a shrinking petroleum trade deficit. This stimulating effect, however, has been largely offset by a reduction in real investment by the oil sector more than twice as large as that following the 1986 oil price decline. Hence, the net stimulus since June 2014 has been effectively zero. We found no evidence of an additional role for frictions in reallocating labor across sectors or for increased uncertainty about the price of gasoline in explaining the sluggish response of U.S. real GDP growth. Nor did we find evidence of lower oil costs stimulating other business investment, of financial contagion or of spillovers from oil-related investment to non-oil related investment, of an increase in household savings, or of households deleveraging.

In “Lower oil prices and the U.S. economy: Is this time different?” Christiane Baumeister of the University of Notre Dame and Lutz Kilian of the University of Michigan write that while many observers expected the recent drop in global oil prices to boost the U.S. economy, average U.S. economic growth since June 2014 has been disappointingly low because higher consumer spending from cheaper gasoline has been offset by a dramatic drop in oil-related nonresidential investment—reducing the net stimulus for the U.S. economy effectively to zero.

The authors find that lower oil prices were passed on to the consumer and that consumers did spend their windfall income, raising real GDP by about 0.7 percent since June 2014. However, this stimulus to real GDP growth was largely offset by a simultaneous reduction in real nonresidential investment, reducing real GDP by 0.6 percent.

As Baumeister and Kilian show, the traditional view in undergraduate textbooks that lower oil prices stimulate the economy by lowering the cost of producing domestic goods and services is at odds with the data. Not only are there few industries that heavily depend on oil as a factor of production (such as the transportation sector or rubber and plastics producers), but the stock returns for those industries increased only slightly more than the overall stock market after June 2014, if at all. In contrast, the stock returns of industries whose demand depends on the price of oil (such as tourism and retail sales) have been far above average stock returns, suggesting that the primary channel of the transmission of unexpected oil price declines must have been higher demand for domestic goods and services. This evidence is consistent with a large share of the oil used by the U.S. economy being used by final consumers rather than firms.

Indeed, an alternative view that has gained traction among economists since the late 1980s is that consumers, faced with a windfall gain in income caused by unexpectedly low gasoline prices, spend most of this extra income, stimulating economic growth via a Keynesian multiplier effect. Baumeister and Kilian confirm that U.S. consumer spending increased about as much as predicted by conventional models of the effect of lower oil prices on consumption. Average real consumption growth accelerated from an average annual rate of 1.9 percent between 2012 and mid-2014 to 2.9 percent between the third quarter of 2014 and the first quarter of 2016. Baumeister and Kilian caution, however, that consumption is not the whole picture since the U. S. only imports about half the crude it uses, so the investment response of U.S. oil producers to unexpectedly low oil prices also has an important impact on the overall economy.

The fact that this most recent price drop has failed to translate into much higher real GDP growth has puzzled many observers. One alternative hypothesis has been that the decline in the price of oil may not have been passed on to retail motor fuel prices, but Baumeister and Kilian show that in fact lower oil prices were fully passed on by refiners and gasoline distributors. Another conjecture has been that consumers, rather than spending this extra income, chose to pay back credit card debt or to increase their savings, but this hypothesis is not supported by the data either. Nor do the authors find that increased uncertainty about gasoline prices has depressed automobile demand, slowing overall consumption growth. Finally, with the exception of railroad equipment investment, which declined as oil shipments by rail declined, there is no evidence of reduced investment by the oil sector having spilled over to other investment expenditures.

The authors make a point of comparing the most recent oil price drop with events in late 1985, when a shift in Saudi policies caused a large and sustained decline in the global price of oil in 1986, resulting in an increase in private consumption and a decline in oil-related nonresidential investment – much like today. The main difference between then and now is that the decline in oil-related investment after June 2014 was about twice as large. The magnitude of this decline is not surprising upon reflection, Baumeister and Kilian argue, because the cumulative decline in the price of oil after June 2014 was twice as large as that after December 1985, while the share of oil and gas extraction in GDP was about the same in 2014 as in 1985.

This is not the only difference, however. The authors point out that the price drop in 1986 was caused by developments in the global oil market alone, whereas in 2014-15, it was also associated with a global economic slowdown which is presumably reflected in a lower average rate of growth in U.S. real exports. Had U.S. real exports continued to grow at the same average annual rate of 3.2 percent as between the first quarter of 2012 and the second quarter of 2014, Baumeister and Kilian note, average U.S. real GDP growth after mid-2014 all else equal would have increased by 0.3 percentage points to 2.5 percent (up from 1.8 percent on average between 2012 and mid-2014).

This paper is part of the Fall 2016 edition of the Brookings Papers on Economic Activity, the leading conference series and journal in economics for timely, cutting-edge research about real-world policy issues. Research findings are presented in a clear and accessible style to maximize their impact on economic understanding and policymaking. The editors are Brookings Nonresident Senior Fellow and Northwestern University Economics Professor Janice Eberly and James Stock, Brookings Nonresident Senior Fellow and Harvard University economics professor.