Another Passthrough Bites the Dust? Inflation and Oil Prices

Abstract

A salient feature of recent oil price hikes has been the reduced impact that they seem to have had on general price levels worldwide when compared with previous oil shocks. This paper gathers stylized facts on the evolution of the pass-through of changes in oil prices to general inflation for a broad number of countries so that this decline in the impact of oil price hikes can be quantified and various hypotheses that might explain it can be evaluated. The current surge in oil prices has also been associated with small effects on output. We find suggestive evidence that can explain both this association with output and the reduced impact on inflation. We show that a decline in the exchange rate pass-through, a reduction in the use of oil per unit of GDP, and a macroeconomic environment characterized by low inflation (which, among other things, has limited the need for reactive monetary policy) help to explain the relatively mild effects of the current oil shock on the global economy. Although we focus on the inflationary consequences of oil shocks, the factors we highlight are also consistent with the limited effects of the current oil shock on global economic activity. The casual observation that inflation is lower now in many countries compared with what it was in the 1970s and 1980s, despite increased oil prices, is not a definitive demonstration of a lower pass-through. In the first place, although nominal oil prices have recently set new records, real oil prices are not as high as they were in those earlier decades. The effects of recent oil shocks are being dampened because they have been accompanied in most countries by appreciations of the currency. Also, the high inflation of the 1970s and 1980s was not due to the oil shocks alone; macroeconomic policies then were very accommodative of inflationary shocks. The improved macroeconomic policies in many countries today may also have contributed to a smaller pass-through. Finally, oil prices are not entirely exogenous to the general equilibrium of the world economy, and the effects of an oil price increase on world inflation and output will depend on the nature of the increase, namely, whether it results from a decrease in supply or from strong demand. The main contribution of this paper is the extension of the calculation of the pass-through of oil price increases to inflation to a larger set of countries and the verification of whether the recent decrease of the pass-through is limited to the United States or whether it can be generalized to the world economy. We find that the pass-through has decreased worldwide during the last thirty years. The cross-country nature of our investigation allows us to study in greater detail the factors underlying the decline in the pass-through and mitigates the problem of endogeneity of the oil price that United States- centered studies might face

Article
  • Coauthors: Jose De Gregorio and Oscar Landerretche
  • Published: Journal of LACEA Vol. 7, No. 2 (Spring, 2007)
  • Date: 2007
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