Crude oil prices have dropped over 20 percent the past two weeks, reminding observers of just how uncertain the oil market has become. That uncertainty started in 1973 when the OPEC cartel first drove prices sharply higher by constraining production. During the 1980s and 90s, new offshore oil fields kept non-OPEC supplies growing and moderated price movements. But as these supplies declined, price volatility has been greater than ever.

Crude oil prices soared from $20 per barrel (WTI) in the 2001 recession to a brief peak of $140 early in 2008. Prices dropped back to $40 in the Great Recession and rose back to $120 in 2014 as the economy recovered. And then the cyclical pattern was broken. Oil prices collapsed again, but not because the economy was heading back into recession, but because of the steady rise of oil from shale fields—a dominant new source of oil supply in the world.

The growth in supply from shale temporarily stalled when prices crashed in 2014. Its renewed growth was one big factor leading to the present oil price decline. Other factors were more transitory and chaotic. President Trump’s insistence that he would shut Iran out of the world oil market led to expectations of reduced global supplies and higher prices. It also led the Saudis and Russians to expand output to fill the expected void. So production from the world’s three largest producers rose sharply. And then Trump announced he would not restrict buying from Iran after all. In this environment, the OPEC cartel and the Russians met this past weekend to discuss plans for production targets in 2019, and reportedly agreed to cut production in order to support oil prices. President Trump responded “Hopefully Saudi Arabia and OPEC will not be cutting oil production. Oil prices should be much lower based on supply”.

Is Trump likely to get his wish? On the demand side of the oil market, the growing prosperity in China and the rest of Asia is expanding car markets and the demand for gasoline. This process is likely to continue for decades. On the other hand, car markets in the advanced economies are moving toward hybrids and all-electric cars. Defense, shipping and airline demands for fuel continue to grow as in the past. How this will balance out is hard to quantify. But global demand projections are surely being marked down from those made 5 years ago.

On the supply side, shale is now firmly established and in the hands of the big oil companies. Production will expand to new areas and will be the main source of growth in global oil supplies. Case-in-point: U.S. shale output is expected to reach record highs in December 2018. When rising shale output created great oversupply and crashed the oil price in 2014 to below $40, the less productive shale fields shut down. Current output is centered on more productive fields, so more output would be sustained at $40 today. And unlike conventional oil fields, whose production declines gradually regardless of what happens to price, shale production is price sensitive—so prices should be less volatile as well as lower.

Shale oil has not been around for long. But it has been a wild period from which we can infer a couple of things about the likely future. The business cycle will still cause cyclical oil price movements. But unless the potential supply of shale oil is much smaller than now seems likely, the average price of oil looking forward should be low relative to the experience since 2000.  Big shocks to supply will still lead to price spikes and extended disruptions of supply will still produce extended high prices. But absent such shocks, reasonable judgments about future supplies and demands on the global market suggest the next 20 years will average noticeably lower prices than the past 20. Trump will get his wish. And OPEC cannot do enough to change that prospect.

       

The CEO of Royal Dutch Shell recently projected oil prices will remain “lower forever.” This comes after a decade of the most chaotic gyrations of oil markets since the 1970s. But unlike that earlier period, when production cuts by the new OPEC cartel led to a quadrupling of world oil prices, this one has included both booms and busts in prices. And while the 1970s saw the creation of a producers’ cartel aim at maintaining high prices, this time the highly competitive U.S. shale oil industry has emerged as the dominant new force determining market prices.

A quick look at how all this happened provides guidance for what to expect from here. Since 2000, conservation measures kept oil demand from rising at all in the U.S. and other advanced economies.  But demand from China and other emerging economies has soared, raising global demand by roughly 1 percent a year. Before the Great Recession, this rapid growth in emerging market demand, alongside little change in non-OPEC supplies, allowed OPEC to drive up prices from $20 in the late 1990s to more than $100 by simply maintaining production. The Great Recession brought down prices, but only temporarily. And as the advanced economies recovered and China’s growth continued, oil prices again rose to the $100 range.

The highly competitive U.S. shale oil industry has emerged as the dominant new force determining market prices.

It was in this environment that the new U.S. shale industry began producing in 2009. High prices encouraged the discovery and development of shale fields and production rates grew rapidly, doubling total U.S. production from 5 to 10 mbd (millions of barrels per day). Since early 2015, they have since stayed in a range of $35 to $55, and the growth of shale output has slowed sharply. The big run up in prices revealed how fast the new shale oil industry could expand. And the much lower prices that followed tested how shale would respond to harder times for producers.

Shale oil is revolutionary because production responds much more quickly to price changes than production from conventional fields. While a conventional field’s production declines gradually over a number of years, and it does not pay to stop production once it starts. By contrast, most of a shale well’s production comes during its first year after completion, and work on a new shale well can be postponed after the drilling phase and before the fracturing of the shale structure. So production can be reduced promptly in response to lower prices. And it can be expanded quickly when prices rise or are expected to rise. Shale production nearly stalled when prices briefly got to the low $30s. And with prices nearer $50 in the past few quarters, production is projected to expand from around 9 mbd in the first half of this year to near 10mbd in 2018.

In the longer run, demands from emerging economies will continue their recent growth trends. And the demand from the advanced economies will be contained by environmental pressures along with the move to hybrid and electric vehicles. So on the global demand side, these prospects resemble the past couple of decades. But on the global supply side, the presence of the shale industry changes the game. Barring some serious political disruption of supply, a sustained return to $100 oil is unlikely given the higher shale production it would bring. And a price substantially below the recent $45 to $50 range would be limited by promptly reduced shale output. This is the new order that shale drilling brings to the formerly chaotic oil market. And it is why “lower prices forever” is a reasonable projection today.

       

Before last Friday’s employment release, some pessimistic observers feared a recession was near. The latest GDP release from the BEA showed real output growth slowed to a crawl in the first quarter, rising at an annual rate of only 0.7 percent. And that followed the report on March employment that had shown an abrupt slowdown in job growth. Alongside this economic news, the previously soaring stock market levelled off.

But the fear among pessimists of a looming recession, which was never convincing, was put to rest by last Friday’s employment report showing 211,000 net new jobs in April, and a very healthy average monthly job growth of 185,000 over the first four months of the year.

As a simple summary of the economic expansion’s health, we should accept the above trend growth in employment over the nearly flat real GDP growth. And as a general rule, we should prefer job growth over real GDP growth as a measure of overall economic activity because the GDP estimates may not accurately correct for seasonal variations and may not properly capture the changing composition and pricing of what we produce and consume.

Going behind the aggregate data, there have been few signs of an overall weakening in the economy. Though some sectors, such as autos, are softening, others, such as defense, construction and many services, are still growing steadily. And the global economy is now less of a drag on the U.S. than it has been. Until recently, weak growth abroad weighed on the U.S. expansion through the exchange rate and trade channels. In recent weeks, the dollar appreciation has stopped. And the present IMF forecasts for 2017 include continued better growth in Europe despite the uncertainties of Brexit and the immigration turmoil, and continued rapid expansion in the emerging market economies. Janet Yellen recently testified that the Fed believes the slowdown in GDP growth is temporary and that it expects to stay on its course of raising policy interest rates further during 2017.

But estimates of how far a healthy expansion can go are highly uncertain. The economy’s growth potential is somewhat greater than many had thought.

Even if the expansion is presently healthy, it has already lasted 8 years, which is old by historical standards. And even before the unemployment rate dropped to April’s 4.4 percent, many analysts believed the economy had reached full employment, which would limit the potential for further economic expansion. But estimates of how far a healthy expansion can go are highly uncertain. The economy’s growth potential is somewhat greater than many had thought. Through much of the present expansion, labor force participation rates declined faster than demographics alone would predict. In recent quarters, as job markets have tightened, the decline in participation has ceased. Furthermore, there is mixed evidence from recent decades about how low unemployment can go without generating accelerating inflation. The Fed is alert to both sides of its mandate, and the fact that it is not raising rates further now but still expects to do so during 2017 indicates it sees and welcomes continued expansion in the economy.

Do these economic prospects tell us anything useful about the stock market and do stock market prices inform our forecasts for the economy? The economy and the stock market affect each other in many ways. A strong expansion raises profits and opportunities for new investment. A rising stock market increases wealth and the optimism of both consumers and businesses. All these connections occur with variable lags. And, in general, market declines do not cause economic declines. But a big market drop could affect wealth and expectations enough to noticeably depress the economy. And some observers reason the surge in the importance of ETFs as a way of participating in the stock market could magnify downward shocks for many investors and, in turn, have more effect on the economy. While mutual funds attracted mainly long term investors, ETFs attract investors who are more likely to trade actively.

The great bull market of the 1990s ended when what we now call the dot-com bubble finally popped. Today, the prices of social media stocks and others related to the Silicon Valley industries (FANG is shorthand for four dominant firms in this category, Facebook, Apple, Netflix and Google), have risen to levels that resemble the star stocks of that earlier boom. Because of their success in the stock market, these high flying stocks are heavily weighted in ETFs indexed to a broad stock average or to growth or high tech stocks. The fear is that, if a correction starts in these stocks, the rush of selling by ETF investors could greatly steepen the stock price decline.

Would that be enough to push the economy into recession? It did in 2001 and the damage would likely be greater in today’s market.

       

Is the great surge in the stock market since Trump’s election a promise of better economic times ahead? It is easy to see why Trump’s core economic proposals sharply raised stock prices and why they could help the expansion in the near term. The rest of the Trump program–the attacks on immigrants and trading partners–promise to hurt the economy both now and in the long-run.

President Trump inherited a healthy U.S. economic expansion that was already among the longest on record and showed little sign of ending soon. In the past three years, employment growth averaged 2.5 million jobs a year, reducing the unemployment rate to 4.8 percent. Some cautious private and government forecasts saw the economy as being very near its potential, or full employment, trend line. But based on the still very modest rise in core prices, and the recent improvements in labor force participation as labor markets tightened, there is room for unemployment to fall considerably more from present levels. And Trump’s proposals promise to help make that happen. They will reduce regulation, cut both corporate and personal tax rates, and increase spending on public works and defense. Taken together, these measures will provide fiscal stimulus at a time when the economy still needs it. Interest rates have risen in response and the Fed is now likely to raise policy rates more quickly than it would have.

The stock market should like these economic proposals for several reasons.  Lower tax rates directly raise after-tax profits. Faster expansion from the fiscal push means higher profits. And reducing regulations cuts costs and raises profits. Banks, which are a clear target for deregulation, also benefit from higher interest rates that raise lending profits. No surprise their stocks have been the best performers in the market rally.

The impact of these budgetary policies in the longer run are more murky. Today’s Congress is likely to give the Administration most of what it asks for. And one big risk in this is that budgetary projections will be made based on dynamic scoring that assumes the programs produce large increases in productivity growth, and so project unrealistically fast growth in the economy’s potential output and revenues. The CBO and Finance Committee make professional assessments of these supply-side effects in estimating future budgetary impacts of tax changes. But the Administration will push for more generous estimates of future revenues that will make the tax and budget proposals more palatable at present. This will only put off dealing with long-run budget deficits and a rising ratio of debt-to-GDP that is projected as the population ages. The adverse effects of swelling debt will be someone else’s problem at some future time.

Much more immediate economic problems are likely to arise from Trump proposals on immigration and trade. We do not yet know much about plans for trade, though we can hope they are addressed through negotiations. But the moves against immigrants have begun.  If the Administration follows through, they are almost sure to disrupt economic activity in the near term and to damage the economy’s growth prospects in the medium and long run.

In recent years, immigrants accounted for roughly half of the annual increase in the labor force. And labor force growth is a major determinant of how fast the economy’s GDP grows in the longer run.  Nobody knows just how far Trump’s policies will go in deporting present workers and how much it will discourage prospective immigrants. But they are likely to substantially reduce the economy’s growth in future years. That means lower tax revenues down the road and greater burdens on remaining workers and retirees.

More immediately, reckless immigration policies will severely damage the agricultural industries that rely on immigrants to harvest crops. And throughout the economy, it will disrupt businesses such as restaurants, taxis, and others that rely largely on immigrant workers. This is a lose-lose proposition. And it can overwhelm whatever benefits there may be in the Administration’s taxing and spending proposals. Let’s hope it gets changed before it derails the economy.

       

One month after the election, a huge market rally shows stock-market investors like the changes Donald Trump will bring to the business world. At the same time, great uncertainty remains about the new Administration’s policies toward the Middle East, Russia, trade relations, and other matters of state and defense. But on the core issues of macro policies for the U.S. economy, he will propose a large fiscal stimulus package and the Republican Congress will gladly go along. Details are still unknown, but they are likely to include lower tax rates on corporate profits and most personal income brackets, a massive public works initiative to modernize the nation’s infrastructure, and regulatory reforms that will favor profits in some sectors.

Not only does the fiscal package promise to promote expansion, it comes at a time when the economy is doing pretty well even without it. Even before the election, the nation’s output was already growing quicker and the labor market was already getting tighter. In the third quarter, gross national output, an average of the income and product sides of the national accounts, rose at a 4.2 percent rate. And the unemployment rate declined to 4.6 percent in October, which was the average rate for 2006-2007 when the last expansion peaked. In this environment, some are alarmed that bond prices have tumbled since the election, seeing this as a signal of excessive deficits and rising inflation ahead.

So is adding fiscal stimulus in today’s environment too much of a good thing? Should Congress therefore balk at large tax or spending changes that add to deficits at this time? Many current economic models use an unemployment rate between 4 and 5 percent as full employment, taken as the rate that can be sustained without steadily accelerating inflation. The inference some will draw is that fiscal stimulus now risks overshooting into the inflationary zone with too low an unemployment rate.

There are two issues here. One is how fast aggregate demand can grow without being constrained by the economy’s potential output level, which recent estimates show to be growing only slowly. The other is whether the Trump initiatives will have important supply-side effects that would make the economy’s potential output grow noticeably faster than these recent estimates, thus permitting a faster growth in aggregate demand and output. Sound infrastructure improvements will improve productivity in the long run, but their effects are spread over a distant future. And as for changes in income and profits taxes, estimates of supply-side effects range from modest to negligible among professional economists and from zero to important among politicians.

Trump will sell his plans for taxes, spending, and regulation as measures that will grow productivity and raise the supply side potential of the economy. He is not reluctant to exaggerate. But even if, to be on the safe side, we assume supply side effects are negligible, it is being far too cautious to argue that we are too near full employment for a major fiscal stimulus now. Careful analysis shows that the labor market works most smoothly with a modest positive rate of price inflation. It also shows that there is no dangerous knife edge case with inflation hard to tame once it starts. The lowest annual unemployment rate since the late 1960s was 4.0 percent in 2000 and the core CPI inflation rate then was 2.6 percent. This was about the same rate that prevailed throughout the long expansion of the 1990s. So, although there will be lots of room to argue about aspects of Trumps’ program, an expansionary fiscal policy is the right macroeconomic policy today. And the sharp rise in government bond rates since the election should be seen as a return towards normalcy rather than as a signal of excessive deficits and inflation.

Going from growing the overall economy to helping manufacturing workers who have lost their jobs is a very different matter. When John F. Kennedy was selling his tax cut proposal as a needed fiscal stimulus, he remarked that “a rising tide lifts all boats.” He turned out to be right then, but would have had it wrong lately. The rising tide of the past two decades left some boats on the beach. And it is a tribute to Donald Trump’s stump skills that he won the presidency by appealing to the blue collar workers who were left behind. They lost their jobs through no fault of their own and restoring them is a worthy goal. But does he have a feasible plan for doing it? Interrupting Carrier’s plans to move some jobs to Mexico and threatening Boeing over its Air Force One contract were in Trump’s style, and it might well have some effect at the margins of firms’ decision making. But without legislation that changes incentives, it acts on too small a scale and puts the president’s prestige in opposition to market forces, which is treacherous ground.

Other Presidents have leaned on companies or unions outside public view, but few did so publicly or without clear authority. In the early 1980s, Ronald Reagan interfered with striking air traffic controllers by replacing them with non-union workers. This was a bold action, but one that was specifically within his powers. As for open confrontation with business, Kennedy again comes to mind because he brow-beat the steel industry CEOs into rescinding announced price increases on steel products. But these were the days of great market power by the steel industry and its unions, and JFK was reacting to what he saw as a breach of an understanding to contain inflation under the informal wage-price guidelines that he had introduced. This was a long way from managing how the companies would conduct their production and employment. Trump loves the bully pulpit and he should have some success in using it. And though narrowly aimed programs may have only limited effects, a steady aggregate expansion provides the needed environment for success. The good news is that is now a reasonable forecast.

       

The Federal Reserve is the most second-guessed agency in the government. Congress regularly calls on the Fed Chairperson to explain its actions and part of Wall Street is always blaming the Fed for something it did or did not do. But suffering such scrutiny comes with being responsible for important policy making. A deeper issue, which has persisted for decades, is whether the Fed’s discretion in policy making should be constrained by rules. Even without specifying rules in legislation, which would be hard to imagine, the idea that rules have advantages may have affected policy decisions. And not for the better.

The Fed is mandated to provide high employment with low inflation. And both the actual conduct of the Fed and the general rules that have been proposed, such as the Taylor rule, named after Stanford economist John Taylor, have been informed by this mandate. However, there is always leeway in emphasizing one goal or the other, and most rules advocates argue they would protect against policymakers who, for political reasons, risked too much inflation by being too expansionary.

In fact, history provides little or no cause to question the Fed’s independence from politics or its commitment to both parts of its mandate. The U.S. has had one stretch of high inflation since the Fed gained its independence in 1951, and the origins of that stretch had nothing to do with recklessness at the Fed. And it ended after Fed tightening helped unseat two presidents.

The stretch began near the end of the Vietnam war, when President Nixon removed the price controls that he had applied a year earlier. That removal added to inflation in 1973 and, with hindsight, one could fault the Fed, then led by Nixon’s former economic advisor, for not responding aggressively to this arguably temporary shock. The big surge in inflation then came with the first great oil price shock when the OPEC cartel was formed in late 1973. That quadrupled the world oil price and began a rising price-wage spiral through the tightly indexed wage contracts of that time. After that, a restrictive Fed policy helped bring on the 1974-75 recession that contributed to President Gerald Ford’s defeat.

Inflation was fueled again when the Shah of Iran was overthrown in 1979, sending oil prices still higher. The Volcker Fed responded with a severely restrictive policy that sent short-term rates soaring to 20 percent. This draconian tightening brought on the very deep and long recession of 1980-1982 that helped defeat President Jimmy Carter, and then ended the inflationary surge.

But if the fear of a reckless or politicized Fed has little or no basis in history, what about the idea that rules may simply do better because markets and businesses like the future certainty that rules provide? In the real world, the opposite is almost surely true. Rules rely on past observations, but the economy and its institutions continually evolve. Rules do not keep up while policymakers with discretion can hope to.

Even more important than evolutionary changes, the big challenges to monetary policy come from shocks and surprises that rules cannot anticipate or prepare for. These are the events that make expert discretionary policymaking invaluable. The inflationary shocks of the 1970s and the financial crisis of the Great Recession are the two biggest events in this category. But lesser shocks that are beyond the reach of rules are not infrequent.

During the relatively smooth economic period between the mid-1980s and the mid-2000s, many observers saw the economy as inherently stable and the Fed’s role as effectively passive. The debate over rules vs. discretion subsided and policy models throughout the Fed often presented policy options by relating them to a Taylor rule. That complacency, of course, vanished with the financial crisis and the Great Recession that followed. But in a recent Brookings paper, Narayana Kocherlakota, an academic economist who had favored rules before becoming President of the Minneapolis Federal Reserve, concluded that the attention to Taylor’s rule had kept the Fed’s initial response to the crisis from being as aggressive as it should have been. Even though there is little risk Congress would actually impose policy rules on monetary policy, it would be useful if rules received less attention than Kocherlakota tells us they now do.

       

On Thursday, the 13-nation Organization of the Petroleum Exporting Countries ended its meeting without reaching an agreement on oil production. Some had hoped OPEC would freeze and lower oil supplies to stabilize prices, but Saudi Arabia’s new oil minister and de factor OPEC leader left supplies unchanged.

The gathering in Vienna received plenty of attention similar to previous ones, but it’s time for the world to stop following OPEC meetings.

The truth is that everyone should have stopped paying attention by late 2014 when it became clear the Saudis and other Arab states would not curtail their own output so as to sustain world oil prices that had soared to over $100 a barrel. The price had risen that far because demand for oil had risen with the growth of China and other emerging energy-hungry economies and because hostilities had disrupted oil supplies from some producing nations.

But the big new actor on the scene was North America. Specifically, the rapid rise of oil production in the United States and Canada, made possible by fracking—the development of new technologies to extract oil out of shale and other “tight” deposits. As a result, the Saudis realized that they would have to continually reduce their own production if shale oil production kept rising to keep the overall world oil supply unchanged. And at prices over $100, it would keep rising.

But if that is the basic story, there are many subplots in this operetta. Oil production from Iran had been curtailed because of embargoes imposed on Iranian output by the major powers of the world due to their renegade nuclear program. However, with a new agreement in place designed to curtail that program, the embargo has been lifted and Iran wants to return production to what it would have been without the embargo — it had been responsible for 11% of OPEC’s production in 2012.

The Arab states want to stabilize all members’ production at around recent levels, while Iran wants to go back to its pre-embargo production. Since many of these countries are mortal enemies on non-oil matters, it will be hard to get agreement on this point. Other complications include the disruptions to supply that arise from political and military conflicts in nations such as Venezuela, Nigeria, Syria, and Iraq. The lack of political stability may have sustained the recent rise in oil prices, but they complicate forecasts for the future.

We are currently living through and learning how U.S. producers will respond to current prices of around $50 a barrel, how they may change output, and whether they can survive at lower prices. Some shale fields are profitable at still lower prices but others are indeed closing down – the Saudis and OPEC have been playing this type of long game.

Farther down the road, what happens to oil prices in the future will determine how much U.S. supply will grow, if at all. And U.S. supply, in turn, will be a big factor determining prices across the rest of the world. If that sounds circular, it shouldn’t. Because shale oil production can profitably be turned on and off much more readily than oil from conventional fields, the world price will be sensitive to how productive this new technology turns out to be.

So the world oil market is likely to be uncertain for some time. OPEC could reduce that uncertainty if its members could agree to collude, as they have in the past. In that regard, it is ironic that the greatest oil fields were discovered in the sands of the Middle East early in the 20th century, and that the oil market still depends so heavily on production from countries that are so politically challenged in spite of their century-long liquid gold bonanza.

Will the Arab states curtail oil production enough to allow Iran to expand its own output at higher prices? Answer that and you can imagine a world with relatively stable oil prices. Now figure out at what price U.S. shale production would stabilize, and you can predict the trend in world oil prices. Or at least what that trend would be absent wars, overthrown governments and the like.

Bottom line: OPEC meetings are not as important as they used to be. They could be, if Iran and the Arabs could make friends, but from what we’ve seen today, we will need plenty of luck.

Editor’s note: This piece originally appeared in Fortune.

       

A government’s arsenal for moderating business cycles consists of fiscal and monetary policy. But the U.S. has little scope for using either if a new recession should now emerge. The Fed has only limited options left for stimulating the economy. And political gridlock may prevent any timely injection of fiscal stimulus. How big are the risks we face, and are we really out of options?

Fortunately, continued expansion is the central forecast for the U.S. economy today. Janet Yellen’s public assessments of the outlook are screened less for signs that the economy may need renewed policy easing and more for clues about when the next rate increase will come. But economic forecasts come with a considerable range of uncertainty, and the downside risk is greater if policies cannot be counted on to respond.

Monetary policy is not out of stimulus options, but they are limited. The recovery of the U.S. economy from the Great Recession owes a lot to the Fed’s aggressive and creative use of monetary policy under the leadership of both Ben Bernanke and Janet Yellen. This included dropping the short-term policy interest rates to zero and the quantitative easing program in which the Fed bought large amounts of longer-term securities, including private mortgages as well as government bonds. The recovery would not have been as successful without these policies, especially when foreign economies were weaker and their interest rates even lower. But having already taken these steps, there is now less room to do still more.

For a start, short-term rates could be pushed back to zero or even be made moderately negative, say minus 0.25 percent. As odd as it may seem to pay a bank to hold your money, or your firm’s money, short rates are already negative in Japan and much of Europe. Nonetheless, rates could go only slightly negative without causing serious problems for some financial institutions. And that would not be enough. In fighting past recessions, the Fed has promoted declines of 5 percentage points or more in short term rates. A half-percentage point decline would be far too little to matter much in a new recession.

The Fed could also return to its QE program. And it could do more by buying bonds so as to directly peg longer term rates, which could require much larger purchases than the QE program made. During World War II and its aftermath, the Fed pegged bond rates because the aim of policy was to hold down the Treasury’s borrowing costs. In the Accord of 1951, it obtained the independence to direct policy at stabilizing the economy. Pegging long bond rates now would be a more forceful policy than just pegging short term rates. But with 10-year Treasuries already yielding less than 2 percent, the monetary stimulus available from pegging them lower would be limited.

This leaves fiscal policy as the main tool now available for fighting recession. In a normal political climate, we would expect Congress and the President to come up with some quick and strong fiscal response to any new downturn, as they did in 2009. But there is little chance of such cooperation in today’s political climate, and this year’s elections could continue the political gridlock.

Congressional willingness to take countercyclical steps that boost the deficit may be further reduced by the widespread agreement about the need to reign in the growing national debt n for the long run: Under current policies the Congressional Budget Office projects debt as a percent of GDP rising from 75 percent this year to 86 percent in 2026, and continually higher thereafter. There is no conflict between reigning in our growing debt in the long run and using countercyclical policies when they are needed. But that is a more complicated political speech to give than one that ignores the difference.

Europe is even more at risk and more in need of expansionary fiscal policies. And the hurdles are greatest among the Euro Zone economies where the flexibility to set separate fiscal policies is severely constrained.

Euro zone interest rates are already negative. And Draghi’s European Central Bank, with the permission of Germany and other Euro zone nations, is presently buying bonds to finance member nations’ deficits arising from the deep recession. As last year’s showdown over Greek deficits showed, adding fiscal stimulus to the depressed nations’ budgets is not permitted under present understandings.

If Germany allowed the use of fiscal stimulus, it would greatly enhance the usefulness of ECB bond purchases and the effectiveness of policies to fight recessions in the Euro zone. It would reduce today’s economic risks and would also strengthen the Euro zone structure for the future.

Unfortunately, the chance of getting this move toward greater integration within the Eurozone seems, if anything, smaller than the chance the U.S. Congress and the President will cooperate over fiscal policy next year.

Editor’s note: This piece originally appeared in Real Clear Markets.

       

The stock market started 2016 with its worst first two weeks ever, renewing a decline in stocks that began around mid-2015. In mid-December, the Fed indicated its confidence in the economy’s expansion by finally raising the policy interest rate above zero. Does the falling stock market reflect signs of economic trouble that the Fed missed? What relation is there between stock prices and the economy anyway?

Economists like to cite Paul Samuelson’s long ago quip that the stock market had predicted 9 of the past 5 recessions. It neatly summarizes the much greater volatility of the stock prices and warns against relying on the market as a forecaster of the economy. But it also says the stock market predicted the five recessions that did occur.

Going beyond Samuelson’s sample, what does the experience over the past 50 years show? It remains true that most stock price declines that alarm investors are false alarms as warnings of recession. However, big market declines are a different matter. Wall Street defines a bear market as a decline of at least 20 percent, and by that definition there have been seven bear markets in the past 50 years. The three biggest, ranging from declines of 48 to 57 percent in the S&P index, were associated with the recessions that began in 1973, 2001 and 2007. Bear markets also came with the recessions beginning in 1981 and 1969. So the correlation between big market declines and economic recessions is pretty high. Only the bear markets in 1966 and 1987 were false alarms.

So does today’s stock market decline, which is about half-way to bear market territory, reflect a weakening economy? The preliminary GDP estimates for the fourth quarter, which were released on Friday, showed real output grew at an annual rate of just 0.7 percent. But the picture is less alarming when disaggregated by sectors. Weakness abroad hurt exports and falling prices for commodities, especially oil, hurt business investment. Some of this activity should bottom out soon, especially if oil prices stabilize. By contrast, consumer spending and residential construction were strong in the fourth quarter and their expansion is likely to continue. Real disposable income last year rose by 3.5 percent, and private sector employment, the most robust measure of economic activity, grew by an average of 211,000 a month in 2015, and by 275,000 in December. That does not indicate a weakening economy that would call for a bear market in stocks.

What about economic issues that are not apparent in such macroeconomic data? The slowdown in China’s economy is much in the news and not well understood. But we export little to China so its effect on output here is minor. Oil prices are more important and many observers believe the oil sector poses special economic risks that go beyond the decline in investment spending by drillers and related industries. Defaults on borrowing by U.S. shale producers are soaring. But while the bankruptcies in the oil patch are a serious matter within the industry, they represent conventional lending risks, reflected mainly in declining prices in the high yield bond market where much of this debt resides. There is no reason to believe this debt presents any important systemic risk.

The U.S. economy continues to be an engine for world growth, and the reasoning above suggests the economy will pull the stock market up from its present slump. Policymakers agree. At its recent January meeting, the Fed stressed that it is continually assessing the global risks to its forecast. In today’s uncertain world, that is the best we can ask for.

As for stock market investors, history shows the best advice is buy and hold because stock markets are too volatile to forecast. It also shows that every recession has been accompanied by a bear market. If, contrary to the assessment offered above, you are somehow convinced that you can forecast whether or not the economy is heading into recession, stocks have a lot further to fall before reaching bear market territory.

Editor’s note: This piece originally appeared in Real Clear Markets. 

       

The oil industry is going through its third crash in prices since the formation of the OPEC cartel. Many are wondering when the market will recover and what oil prices will be when it finally does.

The first price crash came in the mid-1980’s, a decade after OPEC’s formation. The second crash came at the onset of the Great Recession in 2008 when oil prices fell from over $100 a barrel to below $40. The third one is the present decline, which began around September 2014. What do the first two experiences tell us about how the present price collapse will play out?

Oil prices affect oil consumption slowly, and they affect oil production in non-OPEC countries very slowly. The OPEC cartel tries to maintain price targets by varying its own production in response to imbalances in the world oil market. This requires cooperation among its members and is far easier to do when the market pressure is pushing prices up than when it is pushing prices down. Maintaining prices is especially hard if the downward pressures are expected to be longer lasting rather than transitory.

The mid-1980s price decline proved to be long-lasting. When the major Mideast oil producers formed the OPEC cartel decades ago, they quadrupled the oil prices from $3 a barrel to $12 by producing a little less oil. Prices rose further in 1979 when the Shah of Iran was overthrown. The huge jumps in oil prices were a boon to oil producers. But they also brought about strong market responses that eventually pushed oil prices down. Non-OPEC production rose as a result of the creation of huge new fields in Alaska, the North Sea and elsewhere. Fuel efficiency became a key selling point in the aircraft and car markets. Oil prices collapsed when OPEC could not agree on output reductions to offset these changes in the global market. More importantly, these changes proved to be lasting, so that from the mid-1980s until 2000, prices rose only gradually from their 1986 lows.

The price collapse of 2008 happened differently and ended differently. By the turn of the century, changes in both the supply and demand side of the oil market started pushing up oil prices. New non-OPEC supplies were proving harder to find, war interrupted some Middle East production, and fuel demand from China expanded rapidly. By the summer of 2008, oil prices rose rapidly had gone above $100. And then the onset of the Great Recession crashed them to below $40. But this sharp drop in demand was transient: China’s fuel needs continued to surge and recovery started in the advanced economies, reviving their fuel demands. Production from the new shale oil industry added to global oil supply, but not enough to keep prices from rising. By 2012, the world oil price was back to over $100, and it stayed there until the present price collapse.

As this survey suggests, the key to today’s oil market is whether the forces that caused the price collapse in the past 15 months were temporary, like those in 2008, or long-lasting, like those in 1986. China’s growth has slowed, and that will be long lasting but may not be a big enough shift to dominate the oil outlook. The growth of the shale industry is much more important. Shale oil production will respond to the price of oil with only a modest lag—a key difference compared to the very slow response of conventional oil fields, and one that cuts both ways. It means supply will be curtailed more quickly in response to low prices. And it also means production will rise more quickly as prices recover.

The recent decline in shale production would suggest we are near a bottom in prices. But a couple of other factors will probably keep prices depressed longer. First, now that the embargo on Iranian exports has been lifted, Iran will be adding 0.5 million barrels per day to its output, and the other OPEC countries have refused to cut their production to accommodate that. Furthermore, oil inventories have been rising for several quarters and are at record levels. Reducing this overhang and absorbing the added production from Iran will both delay a return to normal production trends. The recovery, which might otherwise have started this winter, will probably be delayed until late next year.

When the market does return to trend, shale oil will be the marginal source of new oil and the price will depend on the evolving technology of this new industry. Shale output was soaring with prices at $100, and this rising supply, more than any other single development, is what caused the oil prices to plunge. When oil is back on its long-term price trend, the price is likely to be between $100, which brought forth too much oil, and $40, which in recent quarters was low enough to stop new drilling in some fields. A price near the middle of this range, $70, is a reasonable forecast at this distance.

Editor’s Note: this piece first appeared in Fortune.