A slide into oily stagflation, three decades on

THIS weekend marks the 34th anniversary of the start of the Yom Kippur war. In case you have forgotten, it triggered the world’s first OPEC oil price shock and the awful era of stagflation.

And oil prices are at it again.

They set a new record every day for the past week, briefly rising over $US84 ($97) a barrel on Thursday, but have been rising for months now. Among other things, these higher prices will push up Australian inflation in the September quarter.
While the Reserve Bank of Australia discounts temporary fluctuations in oil prices in setting monetary policy, recent history suggests if higher oil prices persist, they also seep into the central bank’s underlying inflation measure, which does influence policy.

Depending on what’s happening in financial markets, an underlying inflation number for the September quarter of 0.8 or 0.9 would put strong pressure on the RBA board to raise interest rates again in November, and to hell with the election.

Of course, oil prices can be very volatile and there are some obvious temporary factors in the latest oil price rise. These include the hurricane season in the Gulf of Mexico and hedge funds eager to make good on bets that oil would go over $US80.

Oil futures markets suggest it will fall back to about $US70 fairly quickly. But when you recall it was about $US25 a barrel not that long ago, that’s still a high price and raises some important economic issues. After the Yom Kippur war, the world economy suffered both inflation and recession, and there was another bout after the second OPEC shock of 1979. For a long time the classic academic reference on oil and the economy was papers by US economist James Hamilton.

He suggested most US (and hence world) recessions were preceded by a rise in the price of oil. More recently, economists’ views on the relation between oil prices, inflation and growth have changed, in line with the evidence that the world’s industrial economies no longer respond to oil price shocks the way they did after 1973 and 1979.

Weekend Australian