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Wednesday, July 16, 2008

Falling Oil Prices and CPI

by Calculated Risk on 7/16/2008 10:57:00 AM

From MarketWatch: Crude falls over $6 as inventories show surprise increase

U.S. crude inventories gained surprisingly in the week ending July 11, up 3 million barrels to 296.9 million, the U.S. Energy Information Administration reported on Wednesday.
As I noted yesterday, the difference between a moderate and severe recession might be what happens with oil prices:
One of the keys to the base case is that oil prices decline in the 2nd half of 2008 (something I've been predicting for some time). This prediction is based on demand destruction, lower subsidies in certain Asian countries, weaker demand growth in China, and a few other reasons. The fundamentals of supply and demand for oil suggests a small decrease in demand could led to a fairly large decrease in price. If this happens, then that will hopefully lead to Kasriel's "sharp deceleration in inflation".
Usually the headline measure of inflation (CPI) and the core inflation measure (CPI less food and energy) track pretty well with just short periods of divergence due primarily to changes in oil prices. But for the last few years oil prices have risen relentlessly, and CPI has been substantially above Core for an extended period as shown on the following graph.

Falling oil prices would move CPI below Core inflation and might keep the economy out of a severe recession (although the period of economic weakness would still linger for some time).

Inflation: CPI vs. Core