Higher Gasoline Prices Bring Significant Economic Concern
December 15th, 2007 | by Brian Carr |Thanks to a huge jump in gasoline prices, the Department of Labor reported that a key inflationary figure came in much higher than expected, causing many to wonder whether or not the Federal Reserve would be able to continue to cut interest rates to help prop up a slumping economy.
According to the Department of Labor the Consumer Price Index jumped by 0.8 percent during November, which represents the largest jump since Hurricane Katrina. Much of this jump was fueled (no pun intended) by significantly higher energy costs, specifically higher gasoline prices.
While it would be nice if the jump in gasoline prices was simply limited to causing us pain at the pump, it doesn’t appear that we’re going to be so lucky. As the price of gasoline rises, it has a very strong trickle down effect into the prices consumers pay for every day items.
Whether higher gasoline prices drive up the cost of producing a product or simply the cost to deliver a product, manufacturers and shippers aren’t going to eat that rising cost out of the goodness of their hearts. Simply put, because they’re running a business (and would like to keep it that way) more than likely they will find ways to pass the additional cost burden on to the end consumer.
Unfortunately, this jump in inflation couldn’t have come at a worse time, as it has become painfully clear that the American economy - stuck in the worst housing slump in decades, seeing a softening labor market in the face of sliding corporate profits - is entering into an era of much slower growth, if not a period of economic decline.
One of the major tools that the Federal Reserve has at its disposal to help the economy avoid a full-blown recession is the power to cut the “Federal Funds” rate. This rate, which has a profound effect on the rates charged to consumers who borrow money, is usually slashed at times like this in order to stimulate economic growth.
Unfortunately, as the Federal Funds rate is reduced, inflationary risks also increase. It’s this scenario that puts the Federal Reserve in quite a quagmire.
With the economy clearly slowing, the Fed would (theoretically) like to reduce interest rates in order to keep the economy growing, but with clear inflationary pressures, it doesn’t appear that they’re going to be able to drop rates much lower. If things get worse, they may have to actually increase rates, which would put Wall Street into a frenzy, cause Consumer Confidence to drop and probably push the economy over the edge.
Stagflation, anyone?
2007, please meet 1979.
