Is The Fed Responsible for Higher Oil Prices?

Photo: tiseb

Vincent R. Reinhart thinks so. Reinhart, an economist at the American Enterprise Institute and a former director of the Federal Reserve Board’s Division of Monetary Affairs, argues that the Fed’s quantitative easing program has raised the price of oil for American consumers:

Since the Fed firmly signaled in August its intent to launch the latest round of QE, oil prices have risen from $76 to around $100 per barrel.

Why does the Fed’s balance sheet matter for oil prices? The producers of oil as well as other commodities typically sell their output in a worldwide market priced in U.S. dollars. Thus, they care about the current and expected future purchasing power of the dollar and how that will translate into goods and services back home. But QE has been associated with higher inflation and dollar depreciation, which combines to erode the purchasing power of the foreign producers of commodities. Thus, some of the rise in the nominal price of oil has been to catch up with that erosion.

Reinhart argues that the Fed’s expansion of the money supply, coupled with low interest rates, has pushed investors toward riskier investments.

The commodity market has been one outlet for that reinvigorated search for yield. Investment flows into commodity-related vehicles has stepped up noticeably. This has been reinforced by the Fed’s policy of keeping short-term nominal interest rates near zero, which keeps it cheap to do some of that trading on borrowed funds. Such speculation neither produces nor consumes the commodity, so it should have no long-lasting effect on prices. However, over short periods, it can fuel spasms of enthusiasm or angst that trigger wide swings in prices. Oil markets experienced just that about two-weeks ago when futures prices posted their biggest one-day drop.


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  1. Quinton says:

    “QE has been associated with higher inflation” … where is the evidence of this? Core PCE Price Index has been rather low from the beginning of QE through present. Sure, without QE there could have been some deflation, but I don’t buy the causal relationship between QE and oil prices rising.

    It seems like conflicts in Northern Africa would have had the most to do with the fluctuations in oil prices.

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    • Clancy says:

      Exactly right. Also:

      “the Fed’s expansion of the money supply, coupled with low interest rates, has pushed investors toward riskier investments” Isn’t that the whole point? To expand investment riskier than Treasuries? And again where’s the evidence? Interest rates are still very low, there’s still a ton of demand for the safety of Treasuries. Has there been a similar rise in commodities across the board?

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  2. Tom says:


    Most obvious question and answer in history. The fed controls the money supply and they’ve been creating new money like crazy to fund all of this debt spending and to bailout banks all over the world. Of course this inflation has caused price inflation, in everything, not just oil.

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  3. Matthew says:

    @Quinton: Have you looked at the prices of commodities lately? Cotton, wheat, copper, beef, you name it have risen markedly over the past two years. Cotton is at its highest price since the Civil War.

    Since 2000 the price of oil in dollars has risen from ~$25 to ~$100, a 300% increase. Over the same time the price in Euros has risen from €25 to €75, a 200% increase.

    If you don’t believe that the devaluation of the dollar by the Fed caused this massive difference, on what do you base it?

    (As an aside, imagine how much bigger the difference would be if Europe was financially stable and not on the daily edge of collapse due to the PIIGS.)


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    • Imad Qureshi says:

      Supply shocks. In 2003 with expectation of Iraq war becoming a reality, prices of oil went up considerably. I remember prices at the pump going up within a matter of month from $1.09 to $1.40 before March of 2003. This increase further accelerated after the war started and the war wasn’t over within a month as Dubya hoped for. So, most of the 300% increase in oil prices can be attributed to Iraq war and current Middle East crises and part of it to inflation. I would argue that inflation effect is much lower than the effect of supply shock (and also higher demand due to economic growth) in the oil market due to Iraq war and current middle east crises. If you think current oil production from Iraq is same as prewar then you need to take into consideration the effect of sticky prices and higher demand due to growth and look at the difference in demand for oil between 2003 and now and I am sure inflation will barely justify 15 to 20 % of the 300% price increase in last 8 years.

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    • James says:

      But are the different price changes in dollars and euros caused by a) declining dollar; b) rising euro; c) good old suppy & demand; or d) all of the above? And if d, how much of the change is attributed to each?

      And for a third currency, I see the dollar to Swiss franc exchange rate is back to about where it was in ’03-04, when I lived there. So how have oil & other commodity prices fared in that currency? And then how about relative to gold?

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  4. Cañada Kid says:

    Why do we, who live in the United States, feel the aftershock of an expanding money supply? Shouldn’t we be experiencing a rising price level with the expansion of the money supply? It’d make sense that we wouldn’t notice the inflation immediately if all the Gov’s purchases were overseas, but they aren’t: all of these wasteful Keynesian projects by the Bush and Obama administrations have done little except raise the price level.

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  5. Doc says:

    The R. must stand for Right On. Why don’t people see this? If you look at the monetary base, London Gold Fixing and commodity index through year-end 2010 thay all have the same spike. Of course stuff traded in dollars offshore is gong to be more expensive. Guess what hasn’t spiked? The CPI. Making a disnction between core and non-core is specious. Consumers spend a considerable part of their income on food and on energy -both directly and indirectly. The CPI is basically a notional number whosae notions get adjusted to suit political exigencies.

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    • Ryan says:

      I’ve been saying this would happen since QE1. Guess I should have gotten my degree in economics.

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    • Clancy says:

      CPI vs. Core CPI IS in important distinction if you are looking for the cause in price rises. If the rise in commodity prices is due to inflation of the dollar, you should see the same rise in prices across the Core CPI. If the rise is due to good old Supply And Demand (rising demand from developing countries, falling supply due to middle-east instability for oil and bad weather in various places for food) then the Core CPI will show only slight movement relative to commodities.

      Here’s the core CPI: Inflation is low and steady, indicating we have a supply and demand problem. Not a dollar problem.

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      • Alvaro Fernandez-Ravelo says:

        “I can’t eat an iPad!” – response to New York Fed President William Dudley

        CPI affects you discretionary spending and your most basic needs. Hooray for Core CPI if you eat and don’t need transportation.

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      • Alvaro Fernandez-Ravelo says:

        I meant DON’T eat

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  6. jonathan says:

    The first excerpt seems to make sense until you realize that oil producers don’t set a price; the markets set the price for oil. They can produce more or less to influence price but they don’t have the ability to raise their prices to counteract a decline in dollar value. It gets complicated but the main driver of price is oil demand and refining capacity. Assuming demand is there, the incentive is to produce more oil to compensate for any dollar value loss. Even that assumes the dollar loss is meaningful; in what currency the oil producer consumes, in what currency they have debts, all that matters. If they have dollar debts and are owed money in Euros, they can be making money on the increasing spread.

    As someone else has noted, a main reason rates are kept low is because everyone fled to the safety of Treasuries.

    Bottom line: print something from AEI and you should include a disclaimer about objectivity.

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  7. Beyond Ken says:

    Then how come the price of oil in Euros went up the same amount at the same time?

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    • pawnman says:

      Because oil is traded on a global market. The fed floods the American economy with dollars, meaning that the dollars are worth less (not worthless…yet). So it takes more dollars to buy the same amount of something. Because there are more dollars to go around, the cost of oil rises in the global markets, affecting even countries who experienced no such QE.

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  8. jonathan says:

    I wanted to add that other economics people have been looking at the impact of exchange rate fluctuations on the price of oil. They find the main driver is supply and demand and that the relation to dollar value is complicated.

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