The price of oil briefly touched $100 per barrel yesterday, just short of the all-time inflation-adjusted high of $102.81 in April 1980.

According to economic forecasting firm Global Insight, each $10-per-barrel increase in oil prices:

  1. Increases gas prices by 19 per gallon
  2. Cuts consumer spending by one-third of a percent
  3. Reduces employment by 100,000
  4. Adds one-half percent to consumer prices

And, because oil prices have nearly doubled from the $51/barrel levels of January 2007, the above figures calculate out to:

  1. $0.95 more per gallon in 2007 because of oil prices
  2. 1.67% cut to consumer spending in 2007 because of oil prices
  3. 500,000 lost jobs in 2007 because of oil prices
  4. 2.50% increase in consumer costs in 2007 because of oil prices

In addition, oil’s run-up has ignited fears of inflation and of recession, with the possibility that both would exist at the same time.  This rare economic condition is commonly referred to as “stagflation”

Stagflation is a particularly difficult situation for the Federal Reserve because increasing the Fed Funds Rate would increase the likelihood of recession whereas lowering the Fed Funds Rate would increase the risk of inflation.

For now, mortgage rates are benefiting because less evidence of inflation could attract foreign investment in mortgage bonds.  As demand for bonds increases, mortgage rates fall.

Source
Weakened U.S. Economy May Be Facing New Test
Sudeep Reddy
The Wall Street Journal Online, January 3, 2008
http://online.wsj.com/article/SB119930367405362875.html

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