A change in how Americans use energy should allow the Federal Reserve to focus monetary policy decisions on the inflationary impact of the Middle East war oil price shock, new research from the Federal Reserve Bank of Boston says.
In a report released on Thursday, bank economists said that the U.S. economy’s exposure to the global economy has changed “fundamentally” since the 1970s amid more energy efficiency and increased domestic production.
Those changes mean that an oil price surge has less of an impact on inflation relative to the past. Meanwhile, increased domestic energy production means that higher prices can spur employment in the sector, which in turn offsets the sort of job losses that would have happened in the past, bank researchers wrote.
Because the job market hit is more muted now, that also lessens the disinflationary impact that would usually come with broad-based job losses tied to an energy shock, suggesting inflationary pressures would be higher than they otherwise would have been.
"The U.S. economy’s vulnerability to oil shocks has fundamentally changed - it has not been eliminated but rather reconfigured," the economists wrote. "These findings imply that monetary policy should focus more on the inflation effects associated with oil shocks as opposed to the employment effects,” they wrote.
The paper said that the current shock is notable but so far smaller in economic impact than the 1973–1974 OPEC oil embargo or the 1978–1980 Iranian Revolution. The authors also said “the diminished aggregate employment effects of oil shocks reduce the likelihood of stagflation-style tradeoffs between inflation and unemployment that characterized the 1970s.”
The Boston Fed paper was released as Fed officials are struggling to determine the path forward for monetary policy. The Fed is set to meet on June 16-17 in a meeting that will almost certainly see policymakers maintain their interest rate target range at between 3.50% and 3.75%.
Officials are trying to determine whether the jump in inflation pressures created by the U.S.-Israeli war on Iran will need to be tempered by tighter monetary policy. So far, officials are on board with keeping rates steady while waiting to see how the conflict will affect price pressures over the longer run.
The longer the war persists the greater the chance that inflation, which has already been above the Fed’s 2% target for years, will remain persistently high.
Some Fed officials have begun to speculate that interest rate hikes may be needed later this year if inflation does not start to ease, and the Boston Fed research suggests that path might not lead to notable job market pain.
