Will rising oil prices bring stagflation? Stagflation is the combination of high inflation and high unemployment/recession, a phenomenon that Keynesian economists long thought to be impossible—until it happened in the
So will the current spike in oil prices bring about another bout of stagflation? It is certainly possible. First, we must answer two questions: is the current oil price rise inflationary, and is it a drain on our economy that will cause recession and the accompanying unemployment? If both answers are yes, then a continuing rise in oil will bring stagflation.
Is the current rise in the price of oil inflationary? Simply put, inflation is a rise in the general price level. If oil is more expensive, then everything that is made from oil also becomes more expensive. And everything that is transported using oil. And that has any constituent component or process that utilizes oil. So everything becomes more expensive. So yes, a rise in the price of oil does cause inflation. It may take some time to trickle down to the end consumer across all processes, but it will happen. Back up…now it gets more complicated. A rise in general price level is measured in currency, and that currency’s relative purchasing power (its price) fluctuates with its supply and demand. So an oil price rise is not inflationary as long as the rise in the price of oil is paced by a gain in the value of the dollar. But, that’s not happening, with the US dollar on a dive lately—the Canadian Loonie is at $0.90! So, in the end, the answer is still YES: this rise in the price of oil IS inflationary.
Is the rise in the price of oil a drain on the economy that will cause a recession and increase unemployment? That may seem obvious, but let’s work through it. You pay more for oil, but someone gets that money. What do they do with it? Do they spend it back in the economy, buying goods and services that drive economic growth? If so, then it isn’t a drain, just an inflationary re-distribution that has some loss due to inefficiency of unplanned transition—that is, investments made in the past in reliance on low oil prices don’t pay off so well. This can still be recessionary if it is a sufficiently sharp shock caused by enough of an increase in oil prices. What if the money isn’t cycled back into the economy in the classic petrodollar recycling scheme? What if it is spent in the economy of an overseas exporter of oil—say to build the world’s tallest building in
So does that mean that Stagflation is on the horizon? I think it’s quite possible. When the Fed (