Cheap Oil Doesn’t Trickle Down to Goods, Services
With oil prices falling more than 50 percent since July 2014 we would expect the overall price of goods and services, as measured by the Consumer Price Index (CPI), to fall. This price effect would come from the direct impact on gasoline, fuel oil and related items. But what about the indirect effects when oil is an input into production? In this case one expects to see falling oil prices lead to lower production costs and thus bring down prices of other products.
But, when we turn to the data, we find some surprises. The direct impact of falling oil prices on the CPI is undoubtable. It fell 0.65 percent in December 2014 from July, which is mainly accounted for by the decline in oil prices. But it is harder to see the indirect effect when one looks at the components that make up the CPI.
The table below shows that some major CPI components experienced price increases even over the time period of plummeting oil prices.
Table 1: Price Increases for Selected CPI Components between June 2014 and December 2014
|Consumer Price Index for All Urban Consumers: Food||Consumer Price Index for All Urban Consumers: Alcoholic beverages||Consumer Price Index for All Urban Consumers: Prescription Drugs & Medical Supplies||Consumer Price Index for All Urban Consumers: Intracity Public Transportation||Consumer Price Index for All Urban Consumers: New vehicles||Consumer Price Index for All Urban Consumers: Rent of primary residence|
Notes: The prices increases presented at the table are percent change from June 2014 to Dec. 2014, different from commonly used annualized inflation rates. Original CPI data are from US. Bureau of Labor Statistics.
Strong consumer demand may be one of the reasons that could explain why the oil prices declines didn’t have much effect on other prices. Cheaper oil put more cash in consumers’ hand, which lifted their demand for other goods and services. With strong demand, producers don’t need to lower retail prices even when their production costs are lower.
An equally important consideration is the relative importance of oil-related products in the production process. Whether oil-related products are a large or small contributor to production costs plays a critical role in whether oil costs affect final prices.