Oil Spikes and Inflation

June 10, 2008

The lead editorial in Monday’s Wall Street Journal complained that “the policy mix of easy money and rebates isn’t working,” made another plea for the Fed “to protect the dollar with deeds, not words,” and warned about “a rerun of That 70s Show of higher prices but mediocre growth.”

Calling 1970’s growth mediocre is misleading unless one means growth in corporate profits or in equity prices. GDP growth averaged 3.3% per annum that decade, slightly greater than average growth of 3.1% per annum in the 1980’s and 3.2% per annum in the 1990’s and considerably better than 2.3% per annum through 33 of the 40 quarters in the present decade. U.S. CPI inflation incidentally averaged 7.4% per annum in the 1970’s, compared to 5.1% per annum in the 1980’s, 2.9% per annum in the 1990’s, and 3.0% per annum so far this decade.

In checking the empirical underpinning of the Journal’s assertion, an even bigger potential discovery was made. It appears that oil price spikes may depress economic growth in a permanent way. Before the 1970’s, real GDP had expanded 4.2% per annum in the 1950’s and 4.3% per annum in the 1960’s. Growth in the ensuing three decades settled back to a little more than 3% even though inflation dropped considerably, albeit not all at once. The oil price spike from $10.87 per barrel at the end of 1998 to a mean of $32.91 per barrel in March 2003 when the Iraq War began and almost $140/barrel at the end of last week has been even sharper than what was experienced in the 1970’s, and the United States depends on imported oil for a greater share of its needs now than then. It just may be that average growth of 2.3% per annum so far this decade may not be an isolated and temporary setback but rather a second quantum decline as occurred after the 1960’s, which may endure into the next decade and perhaps the one after that.



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