1. ECON240C Oil Price and Inflation Zhengying Cao, Hongtao Xu, Yiling Liu, Jinying Shao, Meng Yu University of California, Santa Barbara, CA

2. ECON 240C Introduction and Motivations Oil supply is a main energy input for US economy. How does oil price impact on the inflation rate? War for Oil?

3. ECON 240C Data Collection Original data since 1970: Monthly CPI (Consumer Price Indexes) Monthly Crude Oil Price Annual % Oil Expenditures in GDP

4. ECON 240C Model Setup CPI Oil Price Inflation rate % change of oil price Time series oil price model Inflation vs % change of oil price

5. ECON 240C -0.5 0.0 0.5 1.0 1.5 7678808284868890929496980002 INFRATE What’s the inflation rate?

6. ECON 240C Correlogram and root test

7. ECON 240C 0 20 40 60 80 100 7678808284868890929496980002 AOILPRICEOILPRICE is the inflation rate at time t. Why? We need normalized oil prices respected to buying power. Inflation adjusted oil price

8. ECON 240C % change of adjusted oil price -40 -20 0 20 40 607678808284868890929496980002 ADJOILPRATE

9. ECON 240C Correlogram and root test

10. ECON 240C PERCENTAGE = C(1) + [AR(1)=C(2),AR(15)=C(3),AR(4)=C(4),MA(1)=C(5),MA(13)=C(6),BACKCAST=1976:04] Estimate Equation

11. ECON 240C Results

12. ECON 240C Forecast of adjusted oil price 10 20 30 40 50 9091929394959697989900010203 AOILPRICEAOILPRICE_F -20 0 20 40 60 9091929394959697989900010203 PERCENTAGEPOILPRICE % change of adjusted oil priceadjusted oil price

13. ECON 240C Inflation vs Oil Price Impacts Lags

14. ECON 240C Inflation rate model INFRATE=C(1)*ADJOILPRATE+C(2)*ADJOILPRATE(-1)+C(3) +[AR(1)=C(4),AR(9)=C(5),AR(11)=C(6),AR(12)=C(7),MA(1)=C(8),MA(9)=C(9),M A(15)=C(10),MA(11)=C(11),MA(12)=C(12),MA(2)=C(13),MA(22)=C(14),MA(8)=C (15),BACKCAST=1976:02]

15. ECON 240C

16. Forecast of the inflation rate -0.4 -0.2 0.0 0.2 0.4 0.6 0.8 1.0 9091929394959697989900010203 INFRATEINFRATE_F

17. ECON 240C Conclusions and Explanations 10% change in oil price will cause 0.06 increase of inflation in current period and 0.08 increase of inflation rate in next period. There is an almost immediate impact on inflation that is roughly proportional to the weight of energy price. Also with more of a lag, the impact of oil price fluctuations on the CPI is indirectly augmented through the use of oil as an input in the production of other goods and services, such as transportation. Finally, the second round effects of oil price shocks cause the concern that higher prices at the gas pumps and factory gates can rekindle inflation expectations and filter though to rising wage pressures with a lag of quarters and even years.

18. ECON 240C Discussion In times of political tension or war in the Middle East, the price of oil tends to inflate. Oil dependency has fallen substantially after 1981.

19. ECON 240C Further Discussions Expenditures for petroleum are currently three to four times smaller than in 1979- 1982. Efficiency improvements, switching to other fuels, and much lower inflation- adjusted petroleum prices all contribute to less utilization of petroleum in the U.S. Several countries, most notably Norway and Russia, have emerged as key competitors to OPEC.