EconSouth (Third Quarter 2002)
The Impact of Oil Prices On Economic Activity
he price for west Texas intermediate crude oil was over $27 per barrel at the beginning of August 2002, representing a 245 percent increase in less than four years. At the end of 1998, by comparison, the same crude was around $11 per barrel. Market price projections reveal that oil prices are not expected to decline much over the next few months.
Oil price increases in recent memory
Different times, different circumstances
In 1999 the rise in oil prices associated with OPEC (Organization of Petroleum Exporting Countries) production cuts, amounting to about a 4 percent fall in world production, was largely an attempt by OPEC to increase revenue in the face of high and strongly growing demand. Similarly, the decline in oil prices during 2001 reflected weaker world demand and OPEC’s reluctance to jeopardize revenues by cutting production. In both cases the impact on inflation and inflation expectations was relatively minor. Measured inflation changed in the short term, but these developments have not significantly altered the outlook for low, stable inflation.
One possible explanation for the differing inflationary outcomes between the 1970s and the 1990s is a change in the monetary policy response in the face of oil price shocks. Many economists have argued that in the 1970s the Federal Reserve tried to counter the negative impacts of the oil price shocks on economic activity by adopting an expansionary monetary policy stance. This policy may have inadvertently provided a stimulus to inflation — stimulus that persisted for a considerable time. Monetary policy has become less accommodating of oil price shocks since then, suggesting that concerns about an upturn in oil’s relative price are more likely to center on the increase’s effect on real economic activity than on implications for the longer-term inflation outlook.
By John Robertson, assistant vice president of the regional research group