Oil Shocks Aren't Necessarily Inflationary

Oil Shock I: World oil prices almost quadrupled between 1973 to 1975, from $3.50 per barrel in 1973 to $13.50, a 286% jump. Result in Germany? Inflation DECREASED from about 8% to 5% during this period, while U.S. inflation more than tripled from 3.65% in January 1973 (not pictured above) to 12.34% by the end of 1974.

Oil Shock II: From 1979 to 1981, world oil prices more than doubled from $15.35 per barrel to $38.34 per barrel. Result? U.S. inflation reached almost 15% in the spring of 1980, while German inflation never got above 6% during the oil shock (see shaded area above).

Bottom Line: The case of German inflation in the 1970s and early 1980s demonstrates that oil shocks are not necessarily inflationary, unless accompanied by "accommodative" (i.e. "easy") monetary policy, like was the case in the U.S. Faced with the same rising world oil prices as the U.S. during both oil shocks pictured above, Germany's inflation was much, much lower than the U.S.

The M2 money supply in the U.S. grew by 25% from 1973 to 1975, and again by 28% from 1979 to 1981, and it was that monetary expansion in the U.S. that caused all prices to rise significantly (including the non-food, non-energy core CPI items, see related post), and not rising oil prices.

Comments

[CLH:]

Oil probably went up in 70s and 80s because of inflation --not the other way around. During inflation everything goes up including wages which is not true now. You are right about the cause of inflation--"easy monetary policy" which we dont have.

You seem to have the same conclusions as I do. You are very careful not to speak of the future. I make my money by what happens in the future. Of course Im sometimes wrong.

I feel Im getting a $30,000 education for nothing.

2008 Jun 15 10:01 AM

[unimpressed...:]

As you, wisely, indicate, government blundering has more to do with runaway inflation than any other factor - yesterday, today, and tomorrow.

However, we cannot ignore the fact that the price of oil is the underlying cause of massive inflation in our country, today. Until we gain control over this and gain energy independence, this problem will continue, unabated, forever. A Paul Volker will not ride to our rescue today because the Fed is helpless to control the situation in the face of the turmoil in the worldwide energy market. Only positive and effective actions to utilize dormant domestic oil resources such as The ANWR, the deep waters of the Gulf of Mexico, off the coast of California, and in the oil shale deposits of Colorado, Utah, and Wyoming will achieve energy independence.

Additionally, the federal government needs to step on the necks of the Democrat power elite in California and force that state to begin refining Alaska crude. Presently, all this American oil is being shipped to Japan because the clowns of Sacramento forbid it to be refined in California.

Furthermore, the know nothing, do nothing Democrat controlled Congress needs a swift kick in their brain section (located south of their beltlines), to authorize more refineries to be built in this nation. To further the cause of energy independence, they must, also, allow more nuclear power plants to be constructed on a crash-emergency basis. In other words, the Democrats must cease being obstructionists and embrace true progress. Otherwise, give them the boot in November. On second thought, give them the boot, regardless, of what they may do from now till then; they cannot be trusted to do the right thing on a continuing basis.

2008 Jun 15 03:01 PM

[CityKitty:]

UneducatedPragmatist: 20% of California oil comes from Alaska, 39% from California.

www.energy.ca.gov/oil/...

2008 Jun 15 06:33 PM

[Jason Rines...:]

To Unimpressed P: The problem is in both parties. I give the President and VP credit in 2002 to introduce an energy bill which included ANWR and offshore. The Republican's held a narrow majority and it got thrown out. The real issue is greed and self-centerdness. Once upon a time between 1946 and 1996 you had a semblence of public service. Now you have U.S. citizens as the government servants. Pain will force the change, even on those on the hill that feel bullet proof with there foolish utopian visions for America while the rest of the world laughs at them.

2008 Jun 16 05:01 PM

[tuj:]

"Oil probably went up in 70s and 80s because of inflation."

Uh no. There was this thing called the Oil Embargo and then another thing called the Iranian Revolution.

2008 Jul 10 07:48 AM

[Brian Coleman:]

No, oil did go up in the 1970s because of inflation. Its just easier for government to point to the Iranians as the boogie man that was the source of all of our problems rather than examine bad government policies. Not all that different than Arab countries blaming Israel for their problems instead of restructuring their economies. In the 1970s when the dollar became de-linked from gold and therefore a fiat currency unmoored from anything tangible the Fed printed massive amounts of currency. The Saudi's as any rational person would do said if you are going to pay us in devalued currency pay us more of it. Prior to the dollar-gold peg being broken, the price of oil was a constant $3.50 a barrel. It was only when the dollar's value became variable that the nominal value of oil also became variable. Pointing to Oil Embargos and the Iranian Revolution is just a convenient distraction from the real problem which was incompetent monetary policy. Afterall, did the Iranian revolution cause copper, silver, lumber and the entire commodities complex to be revalued up? Of course not, the debasement of the currency caused that.

2008 Jul 10 05:23 PM