Jim Hamilton does the patterns. I try to tell the stories.

There is of course the energy expenditure story, which I have tried to tell. In this way higher energy prices lead to recessions because energy income doesn’t easily recycle into the economy.

Because energy income is largely from very long term investments and from access to natural resources there is no way for energy investors to funnel the money they receive easily back into the economy.

So they park it in T-Bills. However, the T-Bill rate is set by the Fed. So, that means unless the Fed recognizes this is happening and offsets it with looser policy, you wind up with a passive monetary contraction. Of course, you can make matters even worse with an active monetary contraction to offset the rising prices.

Modern Monetary folks will get this instantly. Market Monerists can think of it as energy firms holding their sudden flood of money in Hume’s Lockbox. Because, they do so little day-to-day transacting there is no hot-potato effect. Mainstream economists can think of it as a contraction in the IS curve.

Yet, there is another channel through which this can work and that is simply by changing the dynamics of the car market.

So, image that you don’t actually by cars but rent car-services. That is, the services of a car, not services for a car. Then the cost of car rental services are going to depend mainly on: the cost of new cars, how fast cars depreciate, the interest on a car loan and the fuel to run the cars.

Now we ask, how will a spike in gas prices affect the car-service market. Pretty unambiguously it raises the cost of car services. No secondary effects are going to offset the primary effect. We expect then people to buy fewer car services and more of something else.

Normal cross price elasticity stuff.

However, then we can ask, how does the price of gasoline affect the demand for new cars by car-service firms?

Well, the decrease in final demand will depress the demand for cars. However, the increase in the price of fuel may in-and-of-itself increase the demand for new cars. This is because the flow of new cars and fuel are potentially (likely) substitutes in production.

You can produce car services using the 15 mpg old junker that you have or you can toss that one for a new car that gets 30 mpgs.

The net effect on new car demand is the product of these two effects. The decline in car-service demand multiplied by the change in new cars as an input to car service production.

What’s key here though

1) The savings from increasing the flow of new cars is determined in part by model and capacity constraints. So, if Detroit isn’t building cars that radically improve your fuel economy then switching really does you know good. Maybe you buy more imports but then absent the proper international finance channels this will be contractionary for the US.

2) The flow saving also depends on how old your fleet is. So, fuel efficiency improves over time. It also degrades in older vehicles. However, for my mind, its easiest to act like all of the action is on the degradation of older vehicles. That is old vehicles effectively depreciate in fuel efficiency over time both because they themselves are less fuel efficient and because their potential replacement are more fuel efficient.

This latter effect means that the older the stock of cars the more profitable it is to increase the flow of new cars to offset rising fuel prices.

Remember though, this is still against a backdrop of declining car services. So, for the net flow to go up, this input switching effect would have to be greater than the decline in car services.

P.S.

So this last story just stops at the Wicksellian telling. The marginal product of capital may go up or down dragging with it the natural rate of interest and thus in the absence of monetary changes, the economy. There should of course be an MMT telling, a MM telling and an IS-LM telling.

But, I just haven’t though those through beyond a simplistic “people spend/horde more cash” which of course doesn’t just obviously follow from the above story.

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