Saturday, January 16, 2016

Engineers Working in the Oil Patch

From Paul Krugman.  We have never lived through an oil supply bust (i.e., versus a demand bust normally caused by a recession) nor has a oil bust caused a national/global recession.  This past week in the stock market highlights the market coming to grips with a great deal of uncertainty.

"But there is, I believe, something else going on: there’s an important nonlinearity in the effects of oil fluctuations. A 10 or 20 percent decline in the price might work in the conventional way. But a 70 percent decline has really drastic effects on producers; they become more, not less, likely to be liquidity-constrained than consumers. Saudi Arabia is forced into drastic austerity policies; highly indebted fracking companies find themselves facing balance-sheet crises.

Or to put it differently: small oil price declines may be expansionary through usual channels, but really big declines set in motion a process of forced deleveraging among producers that can be a significant drag on the world economy, especially with the whole advanced world still in or near a liquidity trap."

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