Gas Prices and the Economic Recovery

I often get asked my thoughts on the economic recovery. For the most part my answer has included gas prices. For the last three years I've stuck to the same story, we'll continue to slowly recover over the next 4-5 years. But this recovery will be conditional on stable gas prices. If gas prices start to increase drastically ($5/gallon) we will see household dial back consumption which would with near certainty erase any gains that we've made in employment.

Here is a nice article talking about rising gas prices.

With that said, what can be done about rising gas prices?

In the short run not much. We can try to entice OPEC into releasing more oil to the market, but this is very unlikely to happen. OPEC countries have been hurt by the declining value of the dollar (since oil is priced in terms of dollars).

In the long run there are plenty of options (now only if we thought about the long-run 20 years ago). We can certainly increase the supply of oil, but this will only increase our countries dependence on oil by keeping price relatively lower in the short-run. With the increase in oil demand from China and India the modest gains in oil supply will be trumped by added demand. This is not a stable long-run outcome. The United States does not have enough oil to support domestic demand. We will inevitably be a net importer of oil. An increase in supply might keep prices relatively low in 5-10 years, but still higher today (again new demand from China and India).

The solution to high oil prices is to increase oil prices today. Sounds weird, but hear me out. We cannot sustain our current level of oil consumption over the next 20 years. Offshore drilling is a temporary solution and does not make us energy independent (nearly everyone agrees with this). By keeping oil prices low we will remove any incentive private companies have to develop alternative fuel/energy options. By slowly raising gas prices and letting the free market work private companies we find alternative energies profitable. Alternative energies have high fixed costs and as long as oil prices remain low companies will not find these energies profitable.  We can increase oil prices through carbon taxes (yes taxes). By raising the price of oil (slowly) and using the proceeds to help pay off our national debt or offer them back to households in the form of tax credits will reduce our need for foreign oil without jeopardizing the economic recovery.