South-Western EconNews

South-Western College Publishing - Economics

Oil Prices Hurt European Economy

Subject

European Economy

Topic

International Trade

Key Words

Oil Prices, Economic Growth, and Inflation

News Story

Economists around the world have been expecting the European Central Bank to increase interest rates as one move against a nagging inflationary trend. However, with oil trading well above $50 a barrel, the Central Bank has said it will not increase interest rates.

A statement from the European Central Bank notes that the high price of oil was “very unwelcome” and that it was slowing Europe’s economic growth and driving inflation higher. “We are now at a level that is very, very high, said European Central Bank President Jean-Claude Trichet. At the same news conference, Trichet announced that the central bank would not raise interst rates.

One member country, Germany, is a major oil importer and is thus particularly sensitive to price spikes. Chief European economist at London’s Deutsche Bank Thomas Mayer said that high oil prices were most likely the main culprit for Germany’s recent set of bad economic numbers, including February’s surprising 2.2 percent decline in industrial production. “Oil is by far the biggest threat to the world economy, and it is felt most by the weakest link, the European Union,” said Mr. Mayer.

Most economists suggest that Mr. Mayer’s analysis can be applied to other European and world countries as well. Acting as a two- edged sword, higher oil prices tend to hamper economic growth while increasing inflationary pressures.

Inflation remains slightly above the 2 percent threshold set by the European Central Bank. When inflation rises above the 2 percent level, the central bank is expected to act by tightening monetary policy (raising interest rates).

In addition to the bad inflation news, the continuing string of lower growth numbers has caused the European Commission to cut its 2005 economic growth forecast for the 12-nation euro zone to 1.6 percent from 2.0 percent.

Most central bank watchers now believe that a rate hike is not likely to occur very soon, despite Mr. Trichet’s stated hope of tightening monetary policy. Increasing oil prices create cost-push inflation while negating economic growth. Such economic conditions leave the central bank laboring to balance its primary mission of avoiding inflation against its responsibility to foster economic growth.

Questions

1.	What tools are available to the European central bank to fight inflation as it rises above the 2 percent level? How do these tools differ from the U.S. Federal Reserve’s methods?
2.	Using any source available, name the 12 nations that make up the euro zone.
3.	Define cost-push inflation.

Source

Mark Lander, “Europe’s Economy Hit Hard by Rapid Rise in Oil Prices”, The New York Times Online, April 8, 2005.