It has been apparent for some time that changing oil prices no longer pass-through to domestic prices to the same extent they once did. A new study by the central bank of Chile, Another Pass-Through Bites the Dust? Oil Prices and Inflation, provides a useful analysis and explanation of this phenomenon:
This paper presents evidence of an important decline during recent decades in the pass-through from the price of oil to the general price level. We find that this decline is a generalized fact for a large set of countries.
...we use two estimation strategies in an attempt to properly identify the effect of oil shocks on inflation. First, we estimate the traditional Phillips curve augmented to include oil and test for structural breaks in 34 countries. This methodology shows a fall in the average estimated passthrough for industrial economies and, to a lesser degree, for emerging economies.
Second, we estimate rolling vector autoregressions for a subsample of countries for which we have sufficient data. We derive impulse response functions of inflation to oil shocks and interpret the integrals as estimates of pass-through. We find that the effect of oil shocks on inflation has weakened for most of the 12 countries in the sample.
Among the factors that might help to explain this decline, we argue that the most important are a reduction in the oil intensity of economies around the world, a reduction in the exchange rate pass-through, a more favorable inflation environment, and the fact that the current oil price shock is largely the result of strong world demand. These factors help to explain not only why the current shock has had limited inflationary effects, but also why it has had limited consequences for output.
It would seem a 1% to 4% rise in inflation is more significant than a 5% to 10% rise, although there was 20 years of disinflation (where oil, gold, and raw material prices fell). However, I agree, oil has become a smaller proportion of production costs (particularly, in the U.S., which has become a "lighter" and more energy efficient economy); oil is priced in dollars and a weaker dollar (i.e. exchange rates) makes oil relatively more expensive in the U.S.; and demographics raised labor productivity. Also, oil tends to be a tax on consumption.
Posted by: Arthur Eckart | Monday, May 14, 2007 at 09:01 AM
hello friend very interesting post about Why oil prices are not such a problem for inflation anymore thanks for sharing!!!
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