There’s a lot of talk about the direct GDP impact of rising oil prices, via higher gas prices.
But there’s another angle that might concern the markets: Higher oil prices = higher headline inflation = pressure on central banks to tighten.
Of course, a tightening in monetary policy would not be seen as favorable for financial markets, and also it just doesn’t make sense as a policy move, since you’d essentially be adding another headwind to the economy on top of higher oil.
You have to wonder whether the ECB — which is notoriously sensitive about inflation — would step back from the easing the continent so desperately needs.
Investors in the US may wonder whether the dominant Fed view, that rates will be on hold until 2014, might change.
Karl Smith at Modeled Behavior suggests that in the face of rising oil prices, the Fed ought to issue this statement:
Higher oil prices represent headwinds for the US economy and may justify more accommodative action to prevent job growth from slowing.
As he notes: People will freak out: easing in the face of higher prices! But it’s actually the proper response; it’s just not clear that central bankers anywhere will make this heterodox stance.
One more thing, back to the ECB, there is precedent for them to screw up in these situations.
In the Spring of both 2008 and 2011, the ECB in appropriately tightened rates during a weak economy, but with rising oil prices.
Of course, that was under Trichet, who may go down as one of the worst central bankers of the modern era. Maybe Draghi will do better?
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See Also:
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