I have exactly zero knowledge of economics, but I won’t let that stop me from speculating about the effect of high (and increasing) oil prices.
My logic goes like this:
Sustained low interest rates can “overstimulate” the economy leading the government to raise interest rates in order to slow things down (since there is less expansion and fewer new businesses when interest rates are higher).
However, if oil prices are high it has effects similar to those of rising interest rates (more expensive to operate factories, to ship products, etc.). So, the economy slows down even in the absence of an interest rate rise. Hence, no need by the government to raise rates. In fact, to prevent things from slowing down too much, rates may actually fall.
Is this reasoning at all valid. Will interest rates stay low (or go even lower) as oil prices remain high or continue to rise?
Thanks for humouring me.
Although the Fed typically doesn’t take into account the prices of single commodities (in this case, oil) when making policy decisions, in this case, I would be surprised if they continued on their course of steadily raising interest rates for much longer.
Not due solely to oil prices, but the cumulative effect of Hurricane Katrina, prompted someone in the Fed to say rate policy might change. From 8/31: Dow Ends Up 69 on Philadelphia Fed Plan.
A potential problem is that when oil prices rise the price of almost all other goods will rise. This mimics inflation because all those price increases will make the Consumer Price Index (a common measure of inflation) rise. This poses a problem because during periods of high inflation the Fed will usually increase rates to cool off inflation. This poses a problem. Should they raise or lower rates because oil prices are rising? I’m not sure but I would guess that they will see that the inflation is mostly oil related and therefore keep rates down to stimulate the economy through times of high energy prices.