Rising oil prices could be inflationary and deflationary

A number of times in the past, deep recessions have broken out after steep rises in oil prices. Admittedly, oil prices then at least doubled and more energy was used per unit of GDP than now. Nevertheless, it is striking that the recent unrest in the Arab world has lead to little or no fall in stock prices. Particularly considering the fact that the US, for example, consumes around 20 million barrels of oil a day and the extra rise in oil prices of around 20 dollars already works out to 144 billion dollars on an annual basis. That corresponds with around 1.5% of consumer expenditure. Of those 20 million barrels, 8 million are produced in the US. For the economy as a whole, higher oil prices for those 8 million barrels mean robbing Peter to pay Paul; the extra consumers pay for energy ends up elsewhere in the US economy. This does not, however, apply to the around 12 million barrels a day that the US imports. A rise in oil prices of 20 dollars a barrel actually means the US pays 86 billion dollars extra on a yearly basis. The only compensation is that the oil-producing countries will

probably use part of their extra income to import goods from the US. The net loss is therefore limited to around 60 billion dollars on an annual basis. If, however, we allow for the multipliers effects, then this nevertheless means a brake on the growth of the US economy of 0.5% - 0.75%. But that is only the direct effect. After all, higher oil prices mean not only a net loss of purchasing power for the economy as a whole; they can also lead to higher inflation. If this is the case, the central bank will have to implement a less loose monetary policy and this, too, brakes growth.

Incidentally, this will not necessarily curb inflation; it depends greatly on the circumstances in which oil prices rise. If, for example, economic growth is high, there is little reserve capacity in the economy and monetary policy is loose then higher oil prices do, indeed, quickly lead to rising inflation. Especially as, in those circumstances, extra expenditure on energy will be borrowed. If, on the other hand, there is low growth and high overcapacity then rising oil prices only mean that consumers are left with less purchasing power for other expenditure. If they do not borrow the difference, which they generally do not do in those circumstances, then the demand for other products will decline, so the prices for those products will fall or, in any event, rise less.