Sunday, May 06, 2007

Oil, Inflation, Interest Rates

The last time that gas crossed the $3 a gallon I told a few friends that I didn't understand all of the talk of raising interest rates to hold down inflation. When fuel prices jump dramatically it both pushes up costs across much of the economy, and acts as a damper on growth as capital is bled from other areas to pay additional transportation costs. Looking forward oil prices will either drop and the cost pressure will drop with it, or they will stay with us and the economy will reach a new equilibrium.

This is simple supply and demand, raising interest rates doesn't solve the problem. Two things will effect the situation. First increasing supply would reduce prices. However increasing the oil supply can't be done over night. Reducing demand is the other approach. The increased cost reduces demand to some degree.

Tightening the money supply doesn't help either of these. Loosening money would allow for both investments to increase capacity, and investments in more efficient equipment to reduce demand for oil. So why don't the experts see it that way?
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