General Question

SquirrelEStuff's avatar

Are high gas prices the cause or effect of inflation?

Asked by SquirrelEStuff (9171points) September 16th, 2008

I keep hearing the news say that the price of a barrel of oil has dropped, easing inflation fears. I was under the impression that increasing the money supply is what causes higher prices. (More money in circulation means the value of the dollar drops which means it takes more dollars to buy the same good/service) Can someone please explain why high gas prices means high inflation and vise versa?

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12 Answers

EmpressPixie's avatar

Oil is a world-wide commodity marked in US Dollars (USD) that effects basically everything (we all need oil-based products to continue normal life). So we use it as a benchmark a lot. The oil doesn’t change, so if we’re paying more for it the value of our dollar is less.

edited to add: this is over simplifying but gets at the basic premise.

drhat77's avatar

Empress – don’t forget the effect of OPEC and Venezuela and other oil-producing anti-US nations – they definately limit supply, and that affects gas prices beyond simple inflation and dollar values

Lightlyseared's avatar

It can be a vicious circle. ie high oil prices push up the prices of other things by raising the cost to produce and transport stuff. At the same time as the ptice of stuff goes up so does the price of oil.
Theres nothing to say it can’t be cause and effect at the same time.
So in the begining the price of oil was raised and this started to cause inflation. Now inflation is keeping the price of oil high. although the lehman bros thing did reduce the value of crude by quite a bit yesterday I’d be surprised if you notice any difference when you fill your car in the near future.

allengreen's avatar

We are in a Deflationary period, not inflationary. Deflation has to do with banks unwilling to lend and borrowers unwilling or unable to take on more debt. The high commodity prices were caused by over leverage (which is now unwinding) and speculation. Gas prices are high as a result of refining the crude into gas. Here is a great blog to understand these issues….

marinelife's avatar

They are one contributing cause. You may have noticed that the price of oil is down, but the price of gasoline is up. Whatever they can get away with.

allengreen's avatar

Maybe if we can put another person from an oil producing state into the White House prices will go down?

Michael's avatar

Yikes. Several things wrong in the answers to this question.

First, @Empress, when you say the “oil doesn’t change, so if we’re paying more for it the value of our dollar is less,” that is really a fundamentally incorrect analysis of the economic situation. In a basically free market system (like the one we have), prices are generally set at the intersection of supply and demand (with adjustments based on taxes, regulations, market failures, etc). While the declining value of the dollar no doubt has some impact on the global price of oil, far more important is that global supply is relatively stagnant whereas global demand has increased dramatically. When demand goes up and supply stays the same, prices will rise.

Now, Lightlyseared is on to something. When oil prices rise, so, eventually, do all the things connected to oil. In our economy, that’s a lot of things. Of course gasoline, but also all the goods and services that rely on gasoline (shipping costs, for example, are much higher), in addition to other goods that use petroleum in other ways.

I also want to take issue with allengreen’s assertion that we are in a deflationary period. I don’t see any evidence of this at all. Indeed, according to the bureau of labor statistics, inflation was measured at about 16% from 2004 to 2008. That means, on average, things cost about 16% more today then they did 5 years ago. That’s inflation. If it were deflation, things would cost less.

allengreen's avatar

@michael This should help you understand what deflation is and is not.

According to Austrian economic theory inflation is a net expansion of money and credit. Deflation is the opposite, a net contraction of money and credit. If one accepts those terms, then it is impossible to have inflation and deflation at the same time, in aggregate.

If one chooses to separate the components, then yes, we can have inflation in money supply and deflation in credit. In fact those are the exact conditions I expect to happen. That is also an extremely good environment for gold.

There is no way consumer debt loads can be paid back given falling asset prices, and rising unemployment. Increasing foreclosures and rising defaults on credit cards are proof. Debt that cannot be paid back will be defaulted on. That is deflationary.

It is important to note that credit dwarfs money supply. In deflation, credit will contract at a far greater rate than the Fed prints. This happened in Japan and this also happened in the great depression. I expect it to happen again.

Peter Schiff wrote me to make a very important point. “Remember,” he wrote, “I too forecast a massive deflation, with both asset and consumer prices falling in terms of gold. However, these will clearly not be the case in terms of U.S. paper dollars. While asset prices may indeed fall, consumer goods prices will rise.”

Mish, who is one of the best writers in the blogosphere, has always been careful to specify how he defines deflation. He calls it a contraction of money supply and credit. He does NOT define deflation as a fall in prices (for example, he believes oil prices may go up because of Peak Oil).

Michael's avatar

Ah, a Paulite. Should have known.

In generally accepted economic terms, as well as widely used parlance, inflation/deflation refers to the rising/falling of prices.

When the press talks about inflation, that’s what they are talking about. If you define it differently, then, ok, we’re not experiencing “inflation.” But if you go up to an economist at the Labor Department and ask, “What’s the inflation rate?” she’s gonna tell you about prices.

allengreen's avatar

My friend, you are flat wrong, and I’m not a Paulite, but I do follow Peter Schiff. Read the wikipedia link it will help you understand—asset prices are falling (gold, copper, oil, housing, equities, bonds yields) Debt is being defaulted on. Credit is tightening. Just like Japan 1993–2006. Deflation my friend, it is deflation.

Effects of deflation

In economic theory deflation is a general reduction in the level of prices, or of the prices of an entire kind of asset or commodity. Deflation should not be confused with temporarily falling prices; instead, it is a sustained fall in general prices. In the IS-LM model this is caused by a shift in the supply and demand curve for goods and interest, particularly a fall in the aggregate level of demand. That is, there is a fall in how much the whole economy is willing to buy, and the going price for goods. Because the price of goods is falling, consumers have an incentive to delay purchases and consumption until prices fall further, which in turn reduces overall economic activity – contributing to the deflationary spiral.

Since this idles capacity, investment also falls, leading to further reductions in aggregate demand. This is the deflationary spiral. The solution to falling aggregate demand is stimulus either from the central bank, by expanding the money supply, or by the fiscal authority to increase demand, and borrow at interest rates which are below those available to private entities.

allengreen's avatar

“things cost about 16% more today then they did 5 years ago”——does that not have more to do with a falling dollar than inflation? The dollar has lost some 40% of its value, maybe recenlty has made some gain.

There are inflationary aspects of the economy, but we are in a DEFLATIONARY SPIRAL.

walterallenhaxton's avatar

High gas prices have nothing at all to do with inflation.

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