(CNN) — The national average price for a gallon of regular unleaded gasoline is on the verge of hitting $4 for the first time since 2022.
That price level is relative: A $4 gallon of gas would be welcome in California, Washington state or Hawaii, where the state averages run north of $5 per gallon; while residents of others states where the cost of living is lower are paying under $3.50 a gallon at the pump.
Regardless of the locale, no one’s really a fan of sharply rising gas prices.
Still, the $4 national average serves as a notable threshold – one that carries psychological, mathematical and mechanical implications for the US economy.
“This is worrisome, especially for those who have the least ability to weather the storm,” said Diane Swonk, chief economist at KPMG.
The math behind the estimates
Before diving in to the economic effects of $4-per-gallon gas, it’s important to show one’s work.
Joe Brusuelas, chief economist at RSM US, laid out some of the building blocks of the gas price quantification:
Every $10 increase in the barrel of oil…
- Creates a 0.1 percentage point drag on real GDP growth (the broadest measure of economic activity)
- Increases inflation by 0.2 percentage points
- Raises prices at the pump by 24 cents
- Causes a $450 annual hit to household income
Oil prices have risen by more than $30 a barrel since the war.
A gallon of regular unleaded gasoline averaged $2.98 before the war started.
Economic activity
A $30 increase in oil prices equates to about a 0.3 percentage point knock on real GDP growth (which was 0.7% at the end of last year). While that’s not very big, it tends to add up over time, Brusuelas said.
It’s not easy to topple a $30 trillion economy – a “dynamic and resilient beast,” Brusuelas said.
“However, even a $30 trillion beast has its pain points,” he added.
And the point where things could start getting dodgy isn’t too far away.
When oil prices go above $125 (and gas prices top $4.25 per gallon, and inflation goes above 4%), that’s when conversations grow louder about “demand destruction,” Brusuelas said. In other words, prices get so high that people change behaviors and don’t buy as much.
And some consumers already are changing their behaviors, taking fewer trips if they can and shifting or cutting out spending, said Swonk.
A drop-off in demand can lead to falling prices; however, the supply of oil has been constrained by disruption and destruction, he said.
Inflation
Late last week, oil prices were up $30 from their pre-war levels, which should roughly equate to a 75-cent gas price hike; however, average prices at the pump were up 93 cents, Brusuelas said.
“So, what that tells us, is the risks on inflation are a little bit higher,” he said.
US prices were increasing at an annual rate of 2.4% in February, before the war started, according to the latest Consumer Price Index data.
That could easily jump to 3.5% when the March data is released in a couple of weeks, and the April rate could top 4%, Brusuelas said.
That 1.1 percentage point estimated jump from February seems to blow past the $10 increase = 0.2 percentage point rise; however, it’s also reflective of the sweeping energy-related price increases (such as in diesel and jet fuel) as well as other war-impacted inputs, such as fertilizer.
Those “second- and third-order” effects will be passed along to American households in the months to come – even if the war were to end soon, he said.
“The American public is going to bear the burden of adjustment of this,” Brusuelas noted, adding, “something that’s going on now will still be impacting them come December.”
The economic environment and the Fed
History can sometimes prove helpful when evaluating potential economic impacts of rising gas prices; however, this economy is a different animal than it was even four years ago.
“Back in 2022, the unemployment rate was plummeting, we were generating hundreds of thousands of jobs a month, and a majority of Americans were believing we were in a recession,” said Swonk.
“Now, we’re on the other side of that where we’re generating hardly any jobs in a month – though you don’t need to generate many jobs to hold the unemployment rate steady – but it’s a higher unemployment rate than it was back then.”
Pay gains have slowed, as have opportunities in the labor market. Plus, five years of high inflation have compounded, straining many households in the process. Rising debt levels are increasingly becoming unwieldy, particularly for lower-incomes Americans.
“The level of prices is already too high for too many,” Swonk said.
There are fears that the Federal Reserve could face a “stagflationary-esque” environment (economic downturn coupled with high inflation); however, interest rate shifts can only do so much, she added.
“Uncertainty has just been unprecedently high for a very long time, and that is its own tax on the economy,” she said. “I don’t know how you eliminate uncertainty, unless there’s an abrupt end to the war in the Middle East. Interest rates alone can’t stimulate demand for workers.”