Oil price hike to have less impact on growth and inflation, says OECD

Across the world, strong and rising crude prices have become cause for concern. It is widely believed that the energy market turbulence caused primarily by geopolitical instabilities in the Middle-East North Africa may not only potentially slow down economic activity but also lead to inflation.

The OECD thinks otherwise. In a policy note entitled “The effects of oil price hikes on economic activity and inflation” released in Paris on Tuesday , the OECD says that rising energy prices will only have a modest impact on both GDP and inflation in the near-term.

According to OECD's global model, a $10 increase in the price of oil could reduce economic activity in the OECD area in the second year after the shock by two-tenths of a percentage point. The price shock is expected to raise inflation by roughly two-tenths of a percentage point in the first year and by another on-tenth in the second year, the report asserts.

If the $25 increase in the price of oil that has taken place since the Tunisian uprising were to be sustained, activity could be reduced by about 0.5 percentage points in the OECD area by 2012, and inflation could rise by 0.75 percentage points.

What should be the policy response? The report asserts that given the current low levels of inflation and expectation, monetary policy may not need to react to the recent oil price hikes.

Comments: It is the admitted position that high energy prices invariably contribute to higher prices of a whole range of commodities including food and industrial metals. In countries that practice industrial farming, energy accounts for a third of the cost of grains production. Crude is a universal intermediate and its price does affect a range of economic activities including production and transportation.

It is clear that inferences drawn in the policy note are more appropriate and applicable to OECD area comprising industrialised nations. Inflation expectations there are not very high.

The situation on the ground in developing economies such as India is vastly different. The country is already facing high level of inflation, especially food inflation that hurts the poor the most. Moreover, India's dependence on imported crude oil is as high as 77 per cent and every increase in crude price inexorably fans inflation.

Obviously, the monetary policy (tightening bank credit) followed by developing countries such as India and China over the last several months is an attempt to rein in inflation already at high levels. While developing countries continue to tighten credit, the developed markets such as the US follow a liberal, easy and loose money policy.

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