The are no prizes for guessing why, but oil soared yesterday, passing the $66 a barrel mark on the New York Mercantile Exchange. That is the highest level we have recorded since September last year.
It shows how influential Middle Eastern politics are on the price of oil, and if the British hostages are released in Iran, no doubt the price will fall back down again.
Stepping away from politics into the realm of economics, it is quite interesting to note the correlation between the price of oil and other economic indicators. When oil was high in price earlier last year and in 2005, the high street was performing badly, and as the black stuff started to fall, retail sales picked up.
You might, say, “so what?”, you would expect that. Well, if that is so, maybe you should tell the Bank of England, and other central banks.
When oil was high in price, and demand therefore constrained, the rate of interest was increased. And even today, many are saying the recent run of interest rate rises is just a problem of lag, while we wait for last year’s high fuel prices to drop out of the annual figures.
An increase in the price of products - such as oil - where demand is inelastic, is not necessarily inflationary. Sometimes, an increase in certain prices can lead to a fall in inflation.
Here are two examples of this.
Remember Margaret Thatcher? One of the first things she did was increase VAT, and yet, ultimately, this proved to be an anti inflationary measure.
Remember too that in the days when the retail price index was used as the main guide for inflation, an increase in the rate of interest immediately led to a rise in inflation because mortgage payments rose.
If you believe that actually, in the long term, inflation is caused by demand, then upping the rate of interest when oil is high in price is precisely the wrong thing to do.
In his book - The Death of Inflation - Roger Bootle argued that the growth in capacity created by the expanding economics of India and China has created spare capacity, and therefore inflation was dying.
But is it not the case, that China and India also create consumers? The price of corn has been rising of late, which is surely a sign of rising demand, (in part this is caused by the US government’s scientifically flawed belief that bio fuels are the solution to global warming) rather than constrained supply.
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