The Fed, Inflation, Interest Rates and Oil
Fed Chairman Ben Bernanke testified before Congress that the higher oil prices could make inflation worse. This in turn could lead to higher interest rates.
Federal Reserve Chairman Ben Bernanke told Congress Wednesday that although economic activity is moderating, record-high oil prices have the potential to make inflation worse.
It’s a development that bears close watching, he said.
Delivering his second economic report to Capitol Hill, Bernanke also stressed that these are difficult and uncertain times for Fed policy- makers, saying the climate of slowing growth and rising inflation puts the Fed in a tricky spot in terms of setting interest rates.
No kidding. Bernanke is a new Fed Chairman and if he wants to be seen as a hawk on inflation he may be willing to send the economy into a recession to build up that reputation. Higher interest rates coupled with higher oil prices could push the economy into a recession.
OPEC President Edmund Daukoru has stated that the run up in oil prices is “very uncomfortable” and that there are worries it could have a negative impact on the world economy.
Daukoru, who is also Nigeria’s top oil official, told Reuters the Israel-Hizbollah conflict was responsible for the latest spike, which saw U.S. crude oil futures hit $78.40 a barrel last week, and that OPEC had plenty of spare production capacity should it be needed.
“If it would have stabilized around the mid-60s, I don’t think people would complain too much. We are getting used to that, but the latest shootup to the mid-70s and above is very uncomfortable,” Daukoru said on the sidelines of a conference in the Nigerian capital.
“Clearly the latest flare-up between Israel and Hizbollah that is really the reason for the latest spike,” he said. “It is always unfortunate if we have to address issues outside the power of OPEC.”
High prices bring more revenue to OPEC in the short term, but exporters worry that sustained increases hurt the global economy and encourage consumers to invest in alternative energy.
From an economic theory perspective this contains some interesting issues. Note there is the short term/long term trade offs facing OPEC. Higher oil prices today mean higher oil revenues today, but down the road consumers will cut back, look for alternatives/substitutes and future revenues could be lower at all prices. Similarly, consumers have a trade off, wait and see if the high prices are transitory or take the plunge and invest in more expensive alternatives such as a hybrid car, or something else.
On top of this there is the consumption from growing economies like the Chinese economy as well. The CBO is estimating that under their slower demand growth scenario the impact on U.S. gasoline prices could be $0.19/gallon, and under the higher growth scenario as much as $0.38/gallon.