April 27, 2022

The US inflation reached a forty-year high. Not surprisingly it is front and center in most political and economic discussions. Economists, Pundits, and politicians have pontificated about the sources and “root causes” of the current inflationary surge. In addition to the usual monetary explanation that inflation is too much money chasing too few goods, rising commodity prices has been added to the list by President Biden. Here is what he said. What people don’t know is that 70 percent of the increase in inflation was the consequence of Putin’s price hike because of the impact on oil prices. Seventy percent. A point that is obvious form the data is that since the 1980s divergences between oil prices and the PCE, the fluctuation in oil prices did not result in a corresponding fluctuation in the PCE. In fact, the impact of the oil price changes on the PCE is not discernible. Furthermore, the data shows that the deviation of oil prices from the PCE are temporary and mean reverting. These results suggest that an increase in commodity prices may not be a harbinger of inflation nor will a decline in the price of oil. In fact, the deviations reflect what economists call a relative price change or terms of trade. The price increase reflects the fact that a barrel of oil can be exchanged for a larger quantity of other goods and services.

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