What if They Held an Oil Crisis and No One Showed Up?
The most remarkable thing about the U.S. economy right now is its resilience.
When the price of oil started climbing after Iran succeeded in halting traffic through the Strait of Hormuz, there was good reason to worry that soaring gasoline prices would become a serious economic drag. Far more than creating risk of persistent inflation, higher gasoline prices risked siphoning demand from other parts of the economy. In the worst-case scenario, falling sales would trigger layoffs and raise unemployment, setting off a negative economic spiral.
It did not help that we appeared to be entering the spring with a somewhat sluggish economy, at least on paper. GDP grew at a measly 0.5 percent annualized rate in the fourth quarter of last year, although that was partly because of the prolonged government shutdown. And prior to today, first-quarter GDP growth also looked weak, estimated at 1.6 percent in the second revision released last month.
The data, however, suggest that the American economy powered through the Iran oil shock. Nominal spending climbed 0.7 percent in May after rising 0.4 percent in April. Real spending, which had been flat in April, rose 0.3 percent. Americans adjusted to higher gasoline prices not by pulling back spending elsewhere but by increasing their purchases.
Household Spending Withstood Higher Gasoline Prices
This is even clearer when we look more closely at the inflation-adjusted May personal expenditures data released Thursday. Americans spent more in real terms on cars and trucks, furniture and appliances, and durable recreational goods. We bought more groceries and clothing. Recreational spending climbed. Excluding food, energy, and housing, consumer outlays rose 0.4 percent for the month.
The retail sales figures released a week ago told the same story. Overall sales—which are adjusted for seasonality but not inflation—rose 0.9 percent. Excluding gas stations, sales rose 0.7 percent. And the gains were widespread, including significant increases in sales at auto dealers, health and personal care stores, furniture stores, and online retailers.
There were some signs of strain. Restaurant and bar sales were weak in May. The retail sales data showed a 0.1 percent nominal decline. The personal consumption expenditures figures indicated a 0.3 percent decline in inflation-adjusted spending on food services and accommodations. Transportation services spending—the category that includes airfares—also fell by 0.3 percent (and has declined now for three straight months). Perhaps surprisingly, real spending on gasoline and other energy goods declined 2.4 percent in May, which means households reacted to higher prices by shifting demand away from gas.
A Strong Labor Market Explains the Resilience
Why have households withstood the oil shock so well? For one thing, it appears that many Americans treated the shock as likely to be temporary. When a change in the economy is seen as likely to be transitory, households often do not adjust much in response because it doesn’t alter their long-term expectations for income and prices. Perhaps because the rise in gas prices was so obviously triggered by the war with Iran and that war was not seen as a longterm undertaking, Americans looked past it.
The tax cuts in last year’s One Big Beautiful Bill no doubt also contributed to household strength. This left Americans with bigger refund checks than expected right around the time the higher gasoline bills were hitting. And it meant a smaller share of income of overtime workers, tipped workers, and retirees was being taken by the government.
Finally, there is the strength of the labor market. The economy has added an average of 188,000 jobs per month over the last three months. Layoffs, as measured by jobless claims, have been extraordinarily low. This is contributing to strong income growth. Aggregate income rose 0.7 percent in nominal terms in May and 0.3 percent after adjusting for inflation. Wages and salaries rose 0.4 percent in May in nominal terms, giving working men and women more spending power to compensate for the higher prices of gasoline.
With gasoline prices now falling rapidly—the national average was around $3.92 a gallon on Thursday—those income gains and that level of job security will become a powerful driver of growth in the months ahead. Inflation is likely going to decline rapidly and may even go negative on a month-to-month basis, raising the real spending power of households. That may even be enough to raise those consumer sentiment numbers out of the weird depression they’ve been in for several months.
An important test of economic policy is the ability of an economy to withstand a negative shock. This spring, the U.S. economy passed the test with honors.
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