Saturday, October 25, 2008

Falling Oil Prices Bad News?

Yesterday, oil prices continued their recent downward trend, in spite of the fact that OPEC committed to lower production levels. The financial reports are universally describing this as bad news. That is understandable, as the declining prices indicate that traders are expecting a deepening of the recession resulting in lower fuel consumption.

Of course, gas consumers see another point of view. Besides even that, though, there is another obvious upside to the sharp decline in the price of oil. The drop in the price of oil helps alleviate inflationary pressures on the larger economy. Earlier this year, those setting monetary policy were faced with divergent concerns: on the one hand, there was evidence of a slowing economy; on the other, we were seeing the highest levels of inflation that we have had in a long time. Policies that would expand the economy tend to result in price pressures, so this required the Federal Reserve to make difficult choices. For the most part, they have ignored inflationary concerns in favor of taking steps to try to slow economic decline. This was not uncontroversial, however, and the Fed had to moderate what might have been an even more aggressive approach in order not to push inflation toward double digits, which we have not seen since the end of the Carter administration.

A major pressure point producing rising prices has been energy. The alleviation of that factor should help policy makers be more aggressive in pushing for policies that would stimulate economic growth.

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