The paradox of petrol prices and inflation
Posted July 18, 2008on:
Explain this to me. According to some New Zealand retail banks:
If petrol prices increases, it will slow the economy, which will reduce inflationary pressures, and this will allow the Reserve Bank to cut interest rates.
If the petrol price falls, imported costs are lower, which will reduce inflationary pressures, and this will allow the Reserve Bank to cut interest rates.
Why are some people willing to take contradictory pieces of information as proof of their own fabricated story – this disappoints me. Come-on guys, lets be less reactive and lets use our awesome tools to give New Zealander’s better information!
Personally I think the following, a sudden change in petrol prices is a “relative price” change – it is not inflation in of itself. To decide whether an increase in petrol prices is inflationary or not we have to ask the follow:
- Are there large capacity constraints in the economy,
- How heavily is petrol used as an input to production/in the household budget,
- Do firms and workers have the ability to pass costs on,
If 2 and 3 are the most important factors, then for inflation we should be concerned about a lift in fuel prices. If 1 is the primary factor then lower petrol prices will make inflation worse!
The Bank appears to be mostly focused on the 1st issue (especially as they believe inflation expectations are anchored) – as a result, if petrol was to fall to $80 a barrel it is probably less likely they will cut.
Now it is a complicated issue, and I’m not sure which way it will go. But telling people that both lower and higher petrol prices are inflationary is maddening un-useful.