Rosengren: Dollar's impact on oil is modest
CHATHAM - The weak dollar has had very little impact on the rapid rise in energy prices, Eric Rosengren, president of the Boston Federal Reserve Bank, said today.
Although the decline in the dollar against other currencies has been a popular explanation for oil’s record run, Rosengren said that the data show the increases in oil prices have far outstripped the pace of the slide of the dollar in recent years.
Oil is traded in dollars, and analysts say that when it loses value, it prompts producers to demand higher prices to offset the loss. The weaker dollar also increases demand from buyers who hold stronger currencies and investors seeking a hedge against inflation, analysts say.
But correlating oil prices with changes in the dollar’s value against other currencies shows “the cumulative change in exchange rate pales in comparison to the enormous run-up in oil prices,” Rosengren said. “In other words, the exchange rate cannot explain more than a very small fraction of the change in the dollar price of oil.”
Rosengren made these remarks to open the second session of a Boston Fed conference examining the relationship between inflation and unemployment. He said economists, researchers, and policy makers need to gain a better understanding of how so-called supply shocks that send energy and food prices soaring affect inflation over the long-term.
That question is critical as the Federal Reserve policy makers consider how to react to record food and oil prices in the face of a sluggish economy. The Fed finds itself in a tricky position: if it raises interest rates to fight inflation, it risks worsening the current economic downturn. But if it leaves interest rates too low for too long, it could spark a period of high, persistent inflation.
Lower interest rates encourage borrowing and spending, which increases demand and upward pressure on prices. Higher rates have the opposite effect.
Among the issues economists must consider is whether to craft policies based on total inflation or so-called "core" or underlying inflation. For the most part, policy makers focus on core inflation, believing that short-term swings in food and energy prices have little long-term impact on inflation.
But, Rosengren added, some economists argue that higher food and energy prices are here to stay as rising global demand pressures supplies, changing inflation dynamics.
Historically, Rosengren noted, market forces have eventually reined in high oil prices as supplies rose, demand fell, and technological improvements were introduced.
“That said, it seems to be taking quite a long time to date for the long-run supply and demand influences to rein in oil prices,” he said. “You might say the short-run is getting longer every day."
(By Robert Gavin, Globe staff)
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