South-Western College Publishing - Economics  
Gas Prices Not Fueling Inflation
Subject Oil Prices
Topic Employment, Unemployment, and Inflation
Key Words Gross Domestic Product, Inflation, Recession, Hedging, Futures Markets
News Story

Oil was selling at $11.37 a barrel in February of 1999. Oil prices jumped to more than $25 a barrel in December. In the past, for example, 1973, 1980 and 1990, substantial increases in the price of oil produced significant inflation and led the economy to recession. The doubling of oil prices this year has not had much of an impact on the inflation rate, nor does it appear to be slowing the economy. Productivity increases, new technologies, more efficient markets and deregulation have all been offered to explain why the reaction of today's economy is so much different than in the past.

The economy has become less energy dependent since the start of OPEC in the 1970s. Expenditures on oil were 8.5 percent of gross domestic product (GDP) in 1981, but only 3 percent today. Extensive fuel-consuming industries are less important in today's economy than they were 20 years ago. In 1997 and 1998 the U.S. economy realized its largest energy-efficiency gains in a decade, according to the Center for Energy and Climate Solutions.

Energy-efficiency gains have been made in many industries. Technology improvements have led airlines to replace jets having had three jet engines with two more powerful and more efficient ones. As a consequence, expense for jet fuel has declined from 29.7 percent in 1981 to 10 percent today. There are more gas-guzzling SUVs on the road today, but computer-controlled fuel injection systems and new transmission technologies have helped improve fuel efficiency for the fleet by 5 percent since 1990. More efficient financial markets have also helped cushion industries from the doubling of oil prices. Hedging and long-term contracts insulate industries, at least in the short run, from significant price movements.

The economy has not been immune to the oil price hikes. Inflation is currently at a 2.7 percent annual rate up by a percent from last year's rate. The one percent increase is largely the result of higher oil prices. As long-term contracts expire, the impact of higher oil prices may be somewhat greater, but not at the level of the past. Corporate executives and economic policy makers have learned a great deal about the energy shocks of the past and are in a better position to handle current price changes.

(Updated January 1, 2000)

1. The Federal Reserve is much more aggressive in fighting inflation than it was in the past. Describe possible inflation-fighting strategies of the Fed.
2. Using an aggregate demand and supply diagram, illustrate the impact of higher oil prices on the economy. Describe the effect on real GDP and the price level.
3. What is cost-push inflation? Describe the consequences of cost-push inflation on the economy.
Source Steve Liesman and JacobM. Schlesinger, "The Price of Oil Has Doubled This Year; So Where's the Recession?" The Wall Street Journal, December 15, 1999.

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