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Wednesday, November 19, 2014

'The Effect of Oil Price Declines on Consumer Prices'

From Ben Craig and Sara Millington of the Cleveland Fed:

The Effect of Oil Price Declines on Consumer Prices, by Ben Craig and Sara Millington: Oil prices have declined significantly in recent weeks, reaching levels not seen in several years. At the same time, the year-over-year percent change in the most widely known measure of inflation, the Consumer Price Index (CPI), came in at 1.7 percent for September, which is below policymakers’ targeted levels. Given these circumstances, there is some concern that low oil prices, which have continued to remain below $90 a barrel through October, will keep inflation persistently below or even push it further from targeted levels. A look at historical relationships between oil prices and various price measures can help gauge the potential pass-through of the recent oil-price declines to other domestic prices. ...
Oil price changes can potentially play a large role in the US economy. With respect to inflation, the two most likely channels through which they could do so are retail gasoline prices and producer prices. However, as consumers use savings from lower energy prices for other goods and services, these prices are likely to rise in response, offsetting the initial disinflationary impact of lower oil prices. Accordingly, as the FOMC observed in its Statement on Longer-Run Goals and Monetary Policy Strategy, “the inflation rate over the longer run is primarily determined by monetary policy,” rather than by movements in individual price components.

I'm not as sure as they are that other prices will rise as demand shifts from oil to other goods and services. In an economy like this one where demand is deficient and firms are operating below capacity (and therefore presumably below the minimum point on their average total cost curves assuming they were at or near the minimum before the recession, or at least on the flat part of the curve if the minimum extends over a range of output), shouldn't there be some room for demand to expand without putting upward pressure on prices (e.g. wages shouldn't rise until there are shortages in the labor market, but as noted here there is excess labor supply across the board)? The statement from the FOMC is about the long-run, and an economy operating near capacity, but we aren't there yet and won't be for some time at the present rate of recovery.

    Posted by on Wednesday, November 19, 2014 at 10:30 AM Permalink  Comments (28)


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