Higher energy prices not causing inflation yet

Nick Snow
Washington Correspondent

WASHINGTON, DC, Aug. 23 -- US monetary policymakers are watching to determine if rising oil and natural gas prices are accelerating inflation. But the domestic economy has been able to absorb any impacts so far, the president of the Federal Reserve Bank of Chicago said on Aug. 22.

Economic growth is slowing down to a more normal 3%/year pace from the relatively high 3.5%/year rate of the last 3½ years, Michael H. Moskow said in remarks prepared for delivery to the McLean County Chamber of Commerce in Bloomington, Ill.

Higher energy prices, slowdowns in housing markets, and other factors could push growth lower for a short period, he said. "However, I don't see evidence of a more worrisome downshift in activity."

Energy prices nevertheless pose some economic risk, he said. "Given the large amount we spend on imported energy, increases in oil and gas prices represent a sizable transfer of income from US consumers to foreign producers, which can negatively affect economic growth."

Moskow said: "To date, the rapid increases in energy costs haven't led to much of a slowing in US economic growth. Some of the negative effect of rising oil prices has been offset by solid productivity growth and accommodative monetary policy. Plus, the US economy is less dependent on oil today."

He pointed out that in 1980, it took the energy equivalent of 2.5 bbl of oil to produce $1,000 of real gross domestic product, compared with today's 1.5 bbl of oil equivalent. Also, 11¢ of every $1 of consumer spending went to energy-related expense in the early 1980s compared to 8.5¢ in 2005.

Finally, said Moskow, the increase in crude prices, after adjusting for inflation, is less than the climb during the 1970s and crude remains below the peak reached in 1980 of $86/bbl in 2005 dollars. "Nevertheless, the cumulative effect of higher energy prices may yet have a more significant impact on economic activity going forward," he said.

Core inflation
Moskow said the core inflation rate, which excludes energy and food, has grown from the 1.5%/year that many economists consider an ideal balance to a rate at or above 2%/year for the past 27 months. Higher energy prices are one important reason, even though they are excluded from the core rate, because businesses often to pass higher energy costs through to their own product and service prices. "In fact, the magnitude of the energy and commodity price increases has been large enough to account for a goodly portion of the increase in core inflation," Moskow said.

"Looking ahead, it's likely that core inflation will come down somewhat, but risks remain," he said. "The expected deceleration in economic growth will help avoid the inflation pressures from tightening resource constraints. Moreover, the oil futures market expects that oil prices will stabilize. Should this occur, once businesses adjust their own prices to cover the higher energy costs, overall inflation should return to its earlier rate."

But Moskow also sees a risk that core inflation could run above 2%/year for some time because of further cost shocks and the disappearance of excess domestic economic capacity to help offset their effects on inflation. That could lead to higher inflation expectations, which could boost actual inflation, he warned.

"To date, inflation expectations appear to be contained," he said. "Nonetheless, we have to be vigilant in monitoring these expectations; if they did increase, it would be incumbent on the Federal Reserve to adjust policy in a way that would affirm our commitment to price stability."

He said that while the Fed's Federal Open Market Committee at its August meeting did not raise the federal funds rate target for the first time in several meetings, it could simply be using this period to evaluate the potential inflationary impacts of financial market liquidity, housing markets, economic growth, and rising energy prices before resuming interest rate target increases.

"Recent increases in core inflation have occurred at a time when energy and other commodity prices have been elevated," Moskow said. "We expect these prices to a least level off. Accordingly, the pass-through effects on inflation from these cost increases should wane somewhat. More time and data will help us quantify the contribution of these effects."

Contact Nick Snow at nsnow@cox.net.

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