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June 09, 2004

World: Could Rising Oil Prices Trigger The Return Of High Inflation?

by Mark Baker

As world oil prices rise, there's concern this could re-ignite global inflation. Central bankers around the world are on guard, looking for any sign prices are rising. Already the U.S. central bank is indicating it could raise interest rates soon to dampen price pressures. But economists say they don't expect inflation to come roaring back. They say the world's major economies are still too weak to overheat.
Prague, 9 June 2004 (RFE/RL) -- Rising oil prices around the world are rekindling fears of inflation.

Oil prices recently touched 21-year highs amid concern a terrorist attack in the Middle East could disrupt oil supplies. Those concerns have come at a time when oil demand is growing and supplies are tight.

The fear is that as companies are forced to pay more for energy inputs like oil, they will pass on the increased costs to their customers. Those customers, in turn, will raise their own prices, and an upward spiral will have started.


Something similar happened 30 years ago in the oil price shocks of the 1970s and early '80s, which led to both high inflation and economic recession. Policymakers, looking back to those dark days, would do almost anything to avoid returning to them.

Stefan Schneider, an economist at Deutsche Bank Research in Frankfurt, acknowledges a recent upturn in consumer prices but says this does not necessarily herald a return to general price inflation.

"No, I think you have [to] see that to a large degree as really a temporary rise [in prices], which is due to oil prices. And also -- what we have seen especially in Germany, but also in the other countries -- was a strong increase in [state-controlled] prices -- which is pretty much a one-off," Schneider says.

Schneider says there are major differences between today and 30 years ago. For one thing, he says, the major economies are still too weak after almost four years of slow or no growth. After all, it was less than a year ago that economists were said to be more worried about deflation -- falling prices -- than inflation.

"Underlying [the situation is the fact that] -- especially in Germany, [but in other places, too] -- the economy is still too weak to allow basically the currently higher oil prices to feed into inflation, which would be the one issue that would be of concern to the markets and the [central bank],” Schneider says. “But I cannot see that right now."

In recent weeks, there has been some evidence in both the United States and Europe to suggest that prices are rising -- although still relatively modestly.

In the United States, statistics released last month show prices increasing at an annual rate of about 4.4 percent -- though much of that is said to reflect rising energy costs. This compares to a rise of 1.9 percent for the whole of last year. In Europe's eurozone, inflation in May rose to a 15-month high -- to an annual rate of 2.5 percent. This compares to about 2 percent the month before.

Economists say they need more data to draw any firm conclusions, but central banks are already on high alert to raise interest rates if necessary. The U.S. central bank, the Federal Reserve, later this month, is widely expected to raise its benchmark interest rate for the first time in some four years.

Any sustained return of inflation would be disastrous for the world economy -- and the fragile global recovery now under way. When central banks have to raise interest rates to dampen price pressures, at the same time they restrict economic growth and employment.

In addition, over time, inflation becomes part of a nation's psyche. People come to expect regular price rises -- and this expectation itself becomes a major cause of inflation. Once firmly established, this "expectation-based" inflation is almost impossible to stamp out.

Schneider says that since the 1980s, central banks have succeeded in mostly eradicating these inflation expectations.

"Central banks have generally done quite a good job over the past two decades by anchoring inflation expectations. Consumers and wage earners still believe central banks [will] not allow this price spike of just a few items to end up in a general surge of inflation," Schneider says.

This, he says, will make it easier for them to act this time around -- if rising oil prices do find their way into the general economy.
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