No matter the final results of the Arab Spring—the pro-democracy uprisings that have swept the Middle East from Tunisia to Egypt since December of 2010—the movement has put investors on edge over its implications for the world’s crude oil prices. Political turmoil in the Middle East, and the inevitable threat to oil supplies generated by that turmoil, has long been linked to rising oil prices.
The timing of the Arab Spring has left many economists concerned that an even larger problem may spring from rising oil prices: inflation. The weakened 2010–2013 global economy, still reeling from the disastrous housing bubble implosion of 2008, could hardly bear a sudden spike in inflation that some experts believe could have resulted from the Arab Spring’s increasing oil prices. Not all economists agree that oil prices are solid predictors of inflation in the United States, however; as former Federal Reserve Bank of San Francisco Economist Michele Cavallo opined in a 2008 FRBSF Economic Letter, the volatility of oil prices may preclude them from being accurate predictors. Given the still-fragile state of the US and global economies, the question must be posed: Is there significant evidence to suggest that a strong correlation exists between oil prices and inflation? The answer: No.
Oil, the CPI, and Inflation.
The Consumer Price Index (CPI) measures the inflation that consumers will see in their daily shopping. Rising oil prices certainly do raise the costs of some parts of the CPI; naturally, the energy component of the CPI is directly affected by rising oil prices, and many other components are indirectly affected by the rising energy costs of producing those goods. Nonetheless, economists like Cavallo argue that the core components of CPI, essentially those excluding food and oil, remain far better predictors of inflation than a CPI bundle that includes oil prices.
Though fluctuations in the oil and food markets can be dramatic, they tend to be temporary, as they are typically chalked up to supply shocks; an unexpectedly poor crop or a Middle Eastern political conflict (as in the case of the Arab Spring) can lead to a sudden hike in prices that reflects only a moment’s trouble, and the price hike is usually reversed as soon as the particular situation causing the supply shock is dealt with. The inflationary pressures that accompany fluctuations in the oil market dissipate quickly once oil prices have stabilized.
The sustained crisis generated in the Middle East by the Arab Spring might lead to worries that oil will no longer follow its traditional pattern of a return to price stability after the conclusion of Middle Eastern conflict. After all, the democratic movement could permanently reshape the region’s politics. However, no matter what systems of government Middle Eastern states adopt, their economies will remain dependent on oil exporting, meaning that a large shift away from traditional patterns is unlikely. While oil prices remain a factor in CPI, they can hardly be held responsible for the bulk of inflation, and current core inflation remains a better predictor of future inflation than current inflation figures that include gas and food prices. While the energy market should (of course) remain concerned about the relationship between oil prices and the political climate in the Middle East, western citizens need not fear that rising oil prices will lead to any dramatic uptick in inflation.
This article was written together with Richard Craft, an MBA student who looks forward to helping you understand the global economy. He writes this on behalf of Gulfland Structures, your number one choice when looking for living quarters offshore. Check out their website today and see how they can help your business and its accommodation needs!