OilPriceShocksandInflation-DePaulUniversity.pdfVIP

FRBSF ECONOMIC LETTER Number 2005-28, October 28, 2005 Oil Price Shocks and Inflation Oil prices have risen sharply over the last year, Figure 1 leading to concerns that we could see a repeat of Inflation and the relative price of oil the 1970s, when rising oil prices were accompa- nied by severe recessions and surging inflation. This Economic Letter examines the historical rela- tionship between oil price shocks and inflation in light of some recent research and goes on to dis- cuss what the recent jump in oil prices might mean for inflation in the future. The historical record Figure 1 plots the price of oil relative to the core personal consumption expenditures price index (PCEPI) together with the core PCEPI inflation rate. (Core measures of inflation exclude food and energy prices.) The figure shows that the price of oil jumped sharply twice in the 1970s, as did inflation. But this relationship appears to have dete- riorated over the latter part of the sample; for exam- Note:The relative price of oil is the ratio of the price of oil to the core ple, when oil prices fell sharply in the mid-1980s, PCEPI. core inflation appears to have been unaffected. Similarly, the last part of our sample shows a sus- Hooker’s results—that is, that oil price shocks fail tained increase in the relative price of oil that does to predict inflation over the post-1980 period— not appear to be reflected in inflation. also hold even when the sample is extended to include data through early 2005. Hooker (2002) provided formal evidence of this change in the relationship between oil prices and Does this mean that oil shocks no longer matter inflation over the 1962–2000 period. His model for inflation? The answer depends upon what’s used the rate of change of oil prices, the unem- behind the observed change in the relationship. ploym