Besides the effect on the “real economy” financial markets should be wary about the impact on monetary policy from higher oil prices.Higher energy policies will feed right into inflation readings, and it’s easy to see the world’s central bankers getting jumpy. The ECB has a habit of inopportune policy hikes, responding to high oil prices at the worst possible time.
So what should Bernanke do?
At modelled behaviour, Karl Smith suggests the Fed adopt the following language:
Higher oil prices represent headwinds for the US economy and may justify more accommodative action to prevent job growth from slowing.
In other words: The more oil rises, the more easing!
It sounds completely backwards, but it makes sense.
The point of policy hikes is to prevent the kind of inflation that comes from an overheating economy. That is not what we’re seeing now, as we showed here.
In fact, high oil prices are deflationary, since gas expenditures suck money away from other things.
Check out this chart from BarCap. If you look at commodities ex-gasoline, there trend remains solidly down, with only modest gains this year.
So again, the proper response to oil prices is not to get gun shy and hike rates. It’s to maintain the stance that the Fed is being stimulative, and doing what it can to prevent job loss and deflation.
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