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Cheap Oil Won’t Suppress the Cost of Living for Long

It’s been a recurring storyline in the last couple of years: Plunging energy prices are pushing down the cost of living. But there’s a good reason why you shouldn’t expect to keep seeing it.

While policymakers pay more attention to core inflation (excluding volatile food and energy prices), these volatile expenses inform what households actually pay on a regular basis. So consumers have more direct experience with the headline CPI, from groceries to gasoline, apparel, and education, in trying to gauge whether the cost of living is going up or down.

The headline CPI, released yesterday by the Bureau of Labor Statistics, posted a monthly 0.2 percent decline in February, driven by cheaper oil. Energy prices fell 6.0 percent in February from January, the biggest monthly decline during the past 12 months.

Let’s take a look at how oil prices have related to the CPI in the past several years, and more importantly, how the relation is going to look in the near future.

The chart shows that volatile oil prices don’t always relate to overall consumer prices, but sharp declines in oil prices have always dragged down the CPI. For instance, from June 2014 to January 2015, oil prices fell 55.4 percent and the CPI was down by 1.9 percent. After a short period of rebound in oil prices, they started another round of falling in June 2015. But the CPI on average has been slowly climbing.

Put another way, it isn’t enough for oil prices to merely stay low to hold down the overall cost of living. They need to keep falling.

So in order for oil prices to bring down the CPI this year as much as they did in 2014, oil prices would have to fall at the same rate. But the current oil price is below $40 per barrel. A 55 percent decline would bring it down to below $20, which by many standards is considered unsustainable. In fact, the oil price decline has stalled in recent weeks. Oil prices have picked up in March, which is not reflected in the most recent CPI data for February.

Going forward, even if oil stays as cheap as it is now or slowly rebounds, the downward pressure of cheap oil on the CPI would be largely diminished. In other words, zero growth in oil prices exerts upward pressure onto the CPI compared with big negative numbers in oil price growth in the past.

See our March Everyday Price Index report for how non-energy prices affected cost of living.

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