Gas prices are approaching a nationwide average of $3.50 per gallon, and there's a good chance they'll pass the pivotal $4 mark sometime over the next few months. Upheaval in the Middle East is one obvious factor, since it's boosted oil prices by about $15 over the last month, to about $100 per barrel. Strong economies in China, India, and other fast-growing countries ought to keep demand for oil robust. And gas prices usually rise in the spring and summer anyway, when drivers log more miles, boosting demand.
The last time gas hit $4—in mid-2008—America's drivers freaked out, parking their SUVs, slashing other types of spending, and riding bikes, walking ,or even staying home if it would help save a few bucks. But that's not necessarily what will happen if gas hits $4 per gallon this year. We know now that the economy was headed for a dreadful recession in 2008, and many consumers felt that intuitively. Some drivers have been able to downsize their cars or change their habits over the last three years, making them less vulnerable to higher energy prices. And since high gas prices have an outsized effect on consumer's attitudes, a sober accounting of the real effect on your finances might be more reassuring than you realize.
The typical consumer spends just 5.4 percent of his take-home pay on motor fuel, according to data gathered by the Census Bureau. We spend four times as much paying the rent or mortgage, and more than twice as much on food. Motor fuel is still one of the larger categories of spending, but price hikes that seem large don't affect the average budget all that much. Imagine, for example, that gas prices rose by 25 percent from where they are today, which would equate to pump prices of about $4.20. If you owned a 4-cylinder Honda Accord averaging 24 MPG and drove 15,000 miles per year, your annual fuel costs would rise from about $2,094 to $2,625. That's an increase of about $45 per month, less than some people spend on video rentals or text messaging.
Higher oil prices impact a lot of other things, of course, and would contribute first of all to higher heating costs for people dependent on oil. But household use of electricity, natural gas, and fuel oil accounts for a surprisingly small 3.2 percent of the typical family budget, or about $175 per month. So a 25 percent spike would hike that by about $44. That's roughly an extra $90 so far, based on fairly severe 25 percent price hikes in gasoline and all types of household energy.
Costlier oil also makes many other goods more expensive, since it's one of the commodities needed to harvest and process food and transport a whole range of goods. So it could drive up prices for milk, meat, produce, and some other things, though not by as much as gasoline. Public transportation—including planes, trains, and intercity bus or subway service—could also get more expensive. Altogether, that might add another $50 to the monthly budget.
[See why low inflation seems high.]
Those estimates total about $150 in new expenses each month due to higher oil prices, for a typical family that spends about $4,200 per month, according to the Census. So the higher costs add up to about 3.5 percent of the typical family budget. That's a strain, and it's a much bigger burden for lower-income families, because their energy costs will go up by roughly the same dollar amount, even if they have a lot less disposable income. But a 4 percent increase in average monthly costs isn't enough to justify the kind of bunker mentality consumers displayed in 2008.
A lot of people can offset higher energy costs by spending less on other things. Foregoing the new iPad 2, for example, would be enough to cover those higher costs for three or four months. The typical family spends about $240 each month on entertainment and recreation, which is easier to cut than food or rent. And some things have been getting cheaper, which gives consumers a break, even though they tend not to notice price declines nearly as much as highly publicized hikes in gasoline prices. Many appliances, for instance, have come down in price over the last few years, especially computers and anything else driven by microprocessors. But you're not likely to see many breathless headlines about that. Plus, we tend to apply the savings toward more powerful and better machines—like wall-sized flat-screen TVs—instead of pocketing the difference or saving it for contingencies.
Data on consumer habits also shows that people are buying more efficient cars and appliances and downsizing to smaller homes that cost less to maintain. Those types of changes tend to happen over years, not months, since not everybody can rush to the dealership for a new car with better MPG, just because the price of gas goes up. But overall, we're in a better position to absorb high gas prices now than we were three years ago.
Economists point out that elevated oil prices would need to stay high for at least a year before they had a major impact on the broader economy. Forecasting firm IHS Global Insight says that if oil prices rose by $20 per barrel and stayed there for a year, it would lop about 0.4 percentage points off U.S. GDP growth. If they stayed there for two years, GDP would decline by a steeper 1 percentage point or so. But IHS also points out that that's not accounting for the psychological impact of higher gas prices, which can unnerve consumers and lead to disproportionate cutbacks in spending. It need not be so.