The price of oil

In the past couple of weeks I've witnessed startling signs of how the consumer is suffering in the current economic climate. The local Aldi supermarket is packed, furniture shops virtually empty.
As for prices, we used to buy lamb shanks for $2, they are now $3 each. A box of fruit at our local market has gone up from 10 to $20.
My question is, how much of all this inflation is due to the price of oil?
I happen to think that it is a major factor, and if this is the case, why is the RBA continuing to heap pain on the consumer by raising interest rates.
Australia is a vast country and the increased cost of transporting goods is obviously going to translate into higher prices.
So if the cause of the inflation is oil, rather than discretionary spending, the RBA run the risk of squeezing the consumer dry and bringing the economy to a halt.
I would be very interested to hear the views of other forum members on this matter,
Thanks

I don't know if I'm the best person on these forums to respond to this question as I'm only 23 and haven't really seen a lot (if any) business cycles since I have taken an interest in investing, but here is my two cents anyway.

It isn't just the oil prices driving up inflation (though it is a significant factor) - lots of other factors are weighing into inflation like the Australian mining booms (in addition to high commodity prices) and global food shortages. That said I'm not in a position where I could accurately "guesstimate" what percentage what due to oil, but intuitively I'd think it definitely isn't making up the anywhere near the majority of inflation pressures but is still a very significant factor.

As for why the RBA continues to raise interest rates - well in short the RBA is just attempting to "smooth" the business cycle, because if inflation and growth are left unchecked then it creates a situation where there are more dramatic boom/bust cycles in the economy which might provide great returns in boom periods but unfortunately this is countered by a very unstable environment and dramatic down turns in bust periods where many that don't time the market well will be sent bankrupt and would put a lot of strain on economy not mention build fears around the instability of the economy, which doesn't make for a great investment environment as the majority of us prefer stable returns.

So the RBA believes that rather than having dramatic boom/bust cycles, we are all better off having the RBA employ some monetary policy (interest rates manipulation) to cool and heat up the economy when needed. The government essentially does the same thing on the fiscal policy side of things, reducing spending in periods of high inflation and high growth, and boosts spending to stimulate the economy in periods of low growth.

At the end of the day I don't think the RBA cares if Australians have to do it a bit tougher for a couple of years and stretch those household budgets a bit considering what the alternative is - high unemployment in bust periods. The reality is the vast majority of Australian families can squeeze a few extra dollars out of their weekly spendings to contribute to their mortgage repayments. Alternatively they can't pay their mortgage if they are unemployed. I think once again it isn't scared of bringing the Australian economy to a halt (which it would be hard pressed to do in the near future) considering the Australian economy is still experiencing significantly higher growth than most other develop western countries.

Also in the RBA's defense in the last 17 years Australia hasn't seen an extended period where our real GDP growth has dropped below 2%, and most of the time we have been happily sitting between 3 - 5%.

With all that said, the argument could be made that our inflation targeting method of regulation isn't ideal when the majority of the inflation pressures on our economy aren't being generated by Australia's expansion, but rather inflationary pressures on key world resources. I think that is why the RBA has let inflation get well above its 3% target band and seems to have accepted that our inflation rate will probably be above the 3% target for the next two years, and is wary of the fact that high inflation isn't just an issue in Australia.

Long story short, the world economy is slowing, Australia is no exception, people need to get read to buckle down for a tougher 2 years - the RBA is just giving us the heads up.

While what you say is ostensibly correct Chris, you need to analyse the type of inflation that the RBA is trying to dampen. There is alot of debate over whether it is demand push or supply pull inflation in australia at the moment. This is because of the interest economic environment in which we currently sit. America, the worlds largest economy is experiencing stagflation(low growth, high inflation), where as it is argued that australia is buoyed by ravenous chinese demand. Sim recently posted an article over whether inflation targetting such as monetary policy is effective in real terms because, what it effectively tries to do is target local demand, but if the price of essential goods(oil and food) internationally is racing ahead there is little they can do.
In short I don't think the RBA is currently too worried about the tougher 2 years ahead, it is more worried that australia is growing at a rate that is unsustainable. It a boom is too big, it should be corrected by a large bust.

Cheers,
Eddy

personally I think the global economy is screwed.. dow was down again 200 pts over night.. these oil prices will brng on a depression, like they did once before...

It seems that many people are suggesting that oil is one of the biggest factors in whether this world slow down is going to be relatively light or significant.

There are a fair few people out there suggesting that fundamental prices for oil shouldn't be much more than $100 - $110 and that the current prices are being forced up by speculators, and that the current prices are what are causing so much havoc on economies, with the old catch 22 being that a slowdown should see a drop in the demand for oil, which I imagine might spook the speculators out of the market and putting some strong downward pressure back on oil prices...

That said with reporters loving to hype up the struggles of the world it would seem that everyone would rather predict that oil is going to $250 rather back down to $110 which isn't helping.

So my prediction is there will be further drops on the markets, reports will come out from the US that they are indeed headed for the recession they thought they were going to dodge, China's growth will decline slowly in 2009 after the effect of the Olympics has played through and oil prices will drop back significantly providing some growth stimulus for the world, and the majority of the world will avoid recession, and Australia will continue to do what it does best - grind away.

Australia might keep on doing what it does, but our market doesn't reflect fundementals here, but it responds to what is happening overseas.. ie the US.

Funnily enough, I've started seeing reports this morning predicting that Australia may well hit recession before the US does

Labor comes in and another recession we had to have!

Australians deserve what they get voting out a proven government. why? because they didn't like howard.. well the attack was personal, but the results wont affect Howard, but the whole country.

You look around, everyone is quiet, shops are empty, prices are sky rocketing.. means only one thing... kevin07 recession08 depression09

I don't know where your shopping, but i can't remember seeing more people in shops, both in the cbd, and in the 3 suburban shopping centers i had the misfortune of visiting last weekend!

Anyway, this was an interesting article on SMH this morning.

T's Chief Economist, Chris Caton


Petrol Prices vs The Economy - June 2008

Well the Budget has come and gone, and not much is different. Share markets rose again in May, although not by much, and the US economy continued to send off mixed signals, thus enabling both the optimists and pessimists to maintain their views. I continue to think that there is worse economic news to come from the US, which will be a challenge for share markets.

The continued rise in oil prices was a feature of the month. At end-April, a barrel of West Texas Intermediate cost $116; in late May this price hit $135. Oil prices have doubled in little more than a year. There are those who ascribe all of the rise to “fundamentals” (that is, supply and demand), and there are fanciful forecasts out there that the price may hit $200 per barrel in relatively short order. Count me among the sceptics. Those who claim the price rise is all justified by fundamentals need to be able to identify exactly which fundamentals have changed so much in the past year. Did we not know a year ago that demand in the developing world was likely to continue to rise? Has there been any massive reassessment of the future supply of oil?

If (at least some of) the price rise is not due to fundamentals, then the next move may well be downwards. My personal view is that oil will trade at $100 per barrel before it trades at $150. This, incidentally, is the same forecast that I gave my audiences a year ago.

If oil prices are to retreat, then they will soon begin to dampen inflation, although we have not yet seen the peak effect on overall inflation of the rise to date. The rise in oil prices has, of course, reduced the real income of consumers. In the US, consumer spending is growing more slowly than at any time in the past 16 years, and “working families” are complaining vociferously about petrol prices in Australia, leading both sides of politics to look for means of alleviating the pain. If I am correct, and oil prices do fall, then this latest outbreak of “bad economics” will be halted before it can do too much damage.

Am I the only one who thinks that our politicians should be engaged in weightier matters than ensuring that everyone is free to drive the Tarago at the lowest possible cost? I don’t expect to win many friends by saying so, but we should be taxing petrol more than we are, rather than less.

The consumption of petrol is taxed in every developed country that I am aware of, and for good reason. First, there is an enormous amount of public infrastructure associated with petrol consumption. Why shouldn’t petrol users pay for that? Second, unlike most goods and services that we consume, the consumption of petrol imposes costs on others, mainly in the form of environmental damage and congestion. If petrol is untaxed, then we will use more of it than is socially optimal. In Australia, this tax burden is relatively small; I am aware of just two developed nations, the United States and Canada, that impose a lower tax burden. One can imagine that the present outburst of rampant populism on this issue could well lead to the “quarantining” of petrol when Australia gets serious about reducing carbon emissions. Were this to occur, greater cutbacks will need to be made elsewhere, and the consumer will suffer, with electricity prices, for example, being far higher than otherwise.

There is a further consideration. The “burden” of the increased cost of petrol is commonly exaggerated by stories of how many dollars it takes to fill the family car (imagine that, a problem exaggerated by the media!!). The chart shows the ratio of consumer spending on gasoline to total personal income. It shows that, as of the December quarter last year, this ratio was 2.8%. Data for 2008 are not yet available, but this share is still likely to be little more than 3%. Note that the share was higher for almost the whole time from the onset of OPEC II until early 1987. How can this possibly be true, given that the pump price is so high and, as I showed last month, the price of petrol relative to total consumer prices is at a record high, and about 30% higher than it was in the early-to-mid-80s? There are two main reasons. First, cars are more fuel-efficient than they used to be. Second, in the past 20+ years, our real incomes have risen, but we have not increased the distance that we drive nearly so much.

Petrol spending as a share of personal income

http://www.investsmart.com.au/promo/...graph_june.gif

Ben

Well I've never prospered under a labour government. In fact I left the UK in order to escape one, only to end up with Tony Blair mark 2 here.

I personally think the RBA are going to lead us into a recession that we didn't need to have.
They have turned the screw far too tightly and seem to have paid little regard to the rapid rise in the oil price and the turmoil caused by the credit crunch.
As I said I have noticed a dramatic slowdown up here on the Sunshine Coast.