Petroleum : Inflation Or A "tax Rise"?

[Sledgehead]

Such resolve! Only 5 days ago the Fed donned its new hawkish mask and, from the mouth of their (outgoing) chief, Alan Greenspan, pronounced:

'We had too much experience with the dangers of inflation in the 1970s to tolerate going through another bout of dispiriting stagflation,'

Housing Boom Will Simmer Down, 28 Aug 05, Yahoo Finance

Presumably the Fed was fully aware of the latest inflation figures from the U.S.'s Bureau of Labor Satistics, where it was stated :

"...petroleum-based energy rose 6.1 percent in July, accounting for over one-half of the increase in the overall CPI"

Consumer Price Index Summary, JULY 2005

You might therefore be excused for thinking that to be hawkish on inflation, you'd have to be hawkish on oil prices. WRONG!

In fact, far from worrying about the inflationary effects of higher fuel costs, theh Fed is now worried about the deflationary consequences. Check out their latest missive from the Philadelphia Fed President Anthony Santomero :

"Philadelphia Fed President Anthony Santomero called increasing oil prices a "tax""

The consequence of this extraordinary vault-face?

"... and [santomero] told CNBC it was too early to say whether the Fed would change its interest rate policy in light of the hurricane's wreckage. Many traders took the comment as a signal that the Fed's year-plus streak of rate hikes might end sooner than expected."

Dow Ends Up 69 on Philadelphia Fed Plan, Aug 31st, SFGate.com

Anymore questions on why I put more faith in charts than logic?

Edited September 1, 2005 by Sledgehead

[nickd]

Could this be because a lot of spending on petrol is non-essential and quite elastic?

An increase in petrol prices might meet a US response of driving less, using the small car more than the SUV, trading in the SUV for a small car etc.

In the UK we might walk, cycle, take the bus or shop locally etc.

We might buy local goods as these become better value relative to imported goods. While foreign produce would increase in price, less foreign market for UK food due to transport costs might mean more supply at home therefore cheaper.

If heating fuel goes up we can turn down the heating and wear more clothes.

I could see how we might moderate our spending and activities just like we would for a tax rise, while the overall inflationary pressures would be muted because we would find ways to avoid paying inflated prices. Ebay might become more popular.

If anything it seems in today's wired globalised world there are more opportunities for coping with higher oil prices. Thats a good thing if it means we can creatively respond to higher oil prices and consume less.

Japanese 4-cylinders cars only gained a foothold in the US as result of the 70s crises. Actually today's SUVs probably burn less gas than 70s Cadillacs so we have made some progress, even if far less than we ought to have done.

[Sledgehead]

Could this be because a lot of spending on petrol is non-essential and quite elastic?

<{POST_SNAPBACK}>

I would question whether people view the schhol run as non-essential in a world wher both parents HAVE to work. The same goes for SUV driving. Fine if you can afford to buy a replacement... and putting on another jumper instead of heating ones house? Let them eat cake!

This aside, I wonder how you would extract the inflationary effects of fuel prices from delivery of goods to Asda...

Edited September 1, 2005 by Sledgehead

[MarkG]

Could this be because a lot of spending on petrol is non-essential and quite elastic?

Hardly. Many people would rather cut back on food than petrol. Personally, given that I pretty much only drive to work and make the odd trip to visit my parents, it's almost impossible to cut back on my petrol usage, no matter how expensive it gets.

This is why the government can keep increasing taxes on petrol and raking in more money: we have little choice but to keep buying or dramatically reduce our standard of living. For example, I have occasionally taken the train to work... but it turns a fifteen minute drive each way into over an hour of walking and sitting around each way on a good day, and about once a week when there's 'the wrong kind of heat/snow/rain/whatever' or some chavs riot on the train, over two hours.

An increase in petrol prices might meet a US response of driving less, using the small car more than the SUV, trading in the SUV for a small car etc.

On a timescale of several years, perhaps. On a timescale of a few weeks, not a chance.

In the short term, high petrol prices will suck money out of the rest of the economy. I've seen a number of people online complaining that they have to drive an hour each way to and from work in America: do you really think they'll quit their jobs rather than cut back in other areas to pay for petrol?

Hopefully in the long run this will encouage a rapid switch away from oil towards more sustainable fuels... but in the short run, we'll pay and pay and pay.

I would question whether people view the schhol run as non-essential in a world wher both parents HAVE to work.

Indeed. Mobility is essential to our economy as it currently exists...

Edited September 1, 2005 by MarkG

[Guest magnoliawalls]

We might buy local goods as these become better value relative to imported goods. While foreign produce would increase in price, less foreign market for UK food due to transport costs might mean more supply at home therefore cheaper.

If heating fuel goes up we can turn down the heating and wear more clothes.

<{POST_SNAPBACK}>

Modern agriculture is highly energy intensive - food is unlikely to be cheaper.

In the UK we can certainly turn down the heating and wear more clothes. I lived in Minneapolis for a while - where if you throw away your cup of coffee in winter it can freeze solid before it hits the ground.

High fuel prices will mean that more people die of hypothermia.

[brainclamp]

Economcally it raises costs, reducing the supply quantity at a demand price. It thus moves the price of a product upwards for a given quantity of demand for that product.

According the the marginal cost theory of the firm, it is a factor of supply which raises the marginal cost. Therefore unless other costs for the firm are reduced, interest rates for capital, or wages for labour the quantity produced for a given price must drop.

However, capital costs are fixed and a tiny part of most production, it is the variable costs - i.e. wages which must drop to allow supply at the same given price to meet demand.

It is cost push inflation which will reduce the real growth in the economy, but it is not the same as a tax, as a tax will be redistributed on a macro scale. Its more appropriate to view it as a supply shock, like a bad harvest, even if its cause through a raised demand at a given price.

If the cost of capital is lowered it will have little effect in real terms to producers of goods and services, as interest holders merely get less interest and for most producers the cost of interest is fixed and small per unit. In the end you cannot get a free lunch, and the lowering of real wages would also curtail the consumption of goods and services in the overall economy.

So there you have it. Its a supply shock which raises prices of produce, and lowers growth of real incomes.

If nominal GDP rises sharply with this supply shock, then you will observe rising producer prices trggering an inflationary pricing spiral and yet falling demand which confused many economists in the 1970s.

If nominal GDP stays constant, then you will find a lowering of real output, and rising price inflation, which may mean reduced corporate profits, but most likely not reduced real wages. The only fair way of dealing wth it is to keep nominal GDP constant, and let the economy adjust to it by reducing that part of its spending, buying higher MPG cars etc.. thus lowering demand and bringing prices back in line rationally. .

It is deflationary in one sense, it will deflate the recent record corporate profits as firms simply absorb the costs in thier margin. Perhaps corporate CEO's will face pressure on thier outlandish pay/slice of GDP?

Edited September 1, 2005 by brainclamp

[Sledgehead]

That's a fine reply bc. Much erudition. However, my question was rhetorical.