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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
+1.55% +1.40% +2.66% +0.87% +0.31% +2.02%

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.

7 Comments Post a comment
  1. Gilbert W. Chapman #

    For the first time,during the 4 decades I have read AIER publications, I am disappointed in this analysis.

    Price changes, whether up or down, often take more than a six month period, or even take years.

    One example would be beef retail prices. After the buffoons in Washington decided to use grains for fuel in automobiles, the price of gasoline escalated over a period of years, not weeks or months.

    Perhaps the best example, of all things, is water usage through the flushing of toilets. Years ago the Feds dictated that future, newly manufactured toilets would have to use less water than had been the case for decades.

    Therefore, the only homes to have the ‘new’ toilets were those constructed after the regulation was created. Then, when everyone realized the new toilets didn’t do the job as well as the old style did, people doing bathroom remodeling kept their old toilets; and, it will be even more decades before America is entirely filled with the new design, and water usage will be measurably reduced.


    February 10, 2015
  2. Thanks for your comment. You are right that lags on price changes are important. But, lags in the adoption of changes in physical capital are always much longer. Money lags are much, much shorter. Adoption of grains in fuels or changes in construction technology involve much longer lags than a price change in oil as an input into production. Data tell us that changes in oil prices have already worked through the chain of production. PPI (Producer price index) raw materials for further processing trended down more than 10 percent since last summer. Next, Intermediate PPI goods prices fell about 4 percent, then finished goods PPI dropped about 3 percent. We have reasons to suspect that the price changes in the chain of production would have effects on consumer prices.


    February 11, 2015
    • Gilbert W. Chapman #

      A h h h . . . Now I see where you are coming from . . . And, I suspect you and I, as well as commentator “john b”, aren’t all that far apart . . . At least over the ‘long run’.

      The next year (or two) could be interesting . . . Particularly if oil ‘holds’ at less than $50 per barrel.

      Thank you for your clarifying response.


      February 11, 2015
  3. john b #

    perhaps there is a lag between energy price changes and price changes of other items (the indirect effect). (?)


    February 11, 2015
  4. Yes, John. There is a lag between changes in oil prices and producer prices and then perhaps consumer prices. The lag process between oil prices and producer prices have already been accounted for because the different levels of production have experienced declined prices. Now the question is if the reduced production costs will bring down the consumer prices. As we all know, consumer prices are determined by supply and demand. When we talk about production costs, it is effects from the supply side on consumer prices. If demand stays constant, lower production costs should reduce consumer prices. But as the economy is recovering, we have seen strong demand. If demand is high enough, producers would just simply increase their margins and not change prices or even raise prices. Therefore, the so-called indirect effect may not take place in the near term.


    February 11, 2015
    • john barry #

      Thanks Jia. I am sure some PhD somewhere has looked into this lag as it pertains to energy prices and consumer prices. Not that I need to see it!

      I also think it was Milton Freidman who said that overall price level increases are always and everywhere a monetary phenomenon (or words to that effect); if so so any effect on overall consumer prices resulting from energy price shock would be ephemeral. I am just curious, do you subscribe to that view? I am not sure I do but it makes sense to me.


      February 11, 2015
      • In the long run, too much money chasing goods and services causes inflation. This statement is made under two assumptions. One is the money velocity stays stable (it can change over the time). The other is we focus on the overall price here, not prices of individual goods or services. When it comes to particular goods prices, we say it’s determined by demand and supply. Changes in demand and supply and then changes in the price could be temporary and also rather long term. For instance, if the low oil prices stay as a new normal, it could change the demand for coal over the long run, and thus change the price of coal.


        February 12, 2015

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