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Joe Biden’s Next Economic Nightmare: An Oil Price Shock?

Joe Biden
US President Joe Biden. Image Credit: Creative Commons.

An Oil Price Shock? So much for President Joe Biden’s hopes that inflation will prove to be but a transitory phenomenon caused by factors that do not include his government’s excessive budget stimulus.

No sooner has the Omicron variant been showing the clearest of signs of fading than Russia’s Ukrainian aggression has sent international oil prices to a seven-year high of close to $100 a barrel. This makes it all too likely that in the run-up to November’s mid-term elections, the US economy will experience the politically unpopular combination of high inflation and stagnating output.

In Mr. Biden’s view, the surge in US consumer price inflation to 7 ½ percent, or to a forty-year high, has been largely the result of supply-side factors. These have included disruption to the global supply chain, problems with international shipping, and world food shortages. Mr. Biden keeps hoping that inflation will subside once the world returns to a pre-pandemic normal, which the fading of the Omicron variant would make possible.

A more plausible explanation of inflation’s recent surge has been that, beyond the supply side factors to which Mr. Biden points, the economy has been receiving an excessive amount of budgetary and monetary policy support. In particular, as former Treasury Secretary Larry Summers presciently warned, in March 2021 Mr. Biden was taking large inflationary risks with the economy by rushing through Congress his $1.9 trillion American Rescue Plan. This was all the more so the case considering that the Biden budget boost was occurring at a time when the economy was recovering strongly and when the Federal Reserve had the pedal to its monetary policy metal.

Although the US is a net energy exporter, it would never be a good time for it to experience an international oil price shock that will send gasoline prices ever higher. However, it is a particularly bad time to be subjected to such a shock when inflation is already running at a multi-decade high and when the country is experiencing an equity and housing market bubble courtesy of the Federal Reserve’s bond-buying excesses.

Since the start of the year, international oil prices have already increased by some 25 percent. With the Russia-Ukraine situation unlikely to be resolved anytime soon, there is every prospect that oil prices will remain high for the foreseeable future, especially if sanctions are imposed on the Russian oil sector. That will leave the Federal Reserve with little option but to slam on the monetary policy brakes to prevent domestic inflation expectations from becoming unanchored.

It would seem that the last thing that Mr. Biden needs ahead of this year’s midterm elections is for the US equity and housing market bubbles to burst. Yet that is precisely what could happen if the Fed is indeed forced to hike interest rates to slay the inflationary dragon now being given a further boost by high oil prices. This would seem to be particularly the case considering that both the equity and the housing market bubbles have been premised on the assumption that interest rates would stay at their currently ultra-low levels forever.

The moral of the story is that policymakers play with fire when they heed the sirens of unorthodox theories and throw caution to the wind by pursuing undisciplined budget policies. By so doing, they place the economy at the risk of a hard landing should they run into a streak of bad luck as now seem to be occurring.

Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund’s (IMF) Policy Development and Review Department and was active in staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the U.S. housing market bust, the U.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman is focused on the global macroeconomy, global currency issues, and the multilateral lending agencies.

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Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund’s (IMF) Policy Development and Review Department and was active in staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the U.S. housing market bust, the U.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman is focused on the global macroeconomy, global currency issues, and multilateral lending agencies.

1 Comment

1 Comment

  1. MIKE GUENTHER

    February 22, 2022 at 1:33 pm

    Sorry to say, but the US is now a net IMPORTER of oil. That’s thanks to Biden’s kowtowing to the Green Energy minority in his party. Biden begged OPEC to pump more oil and they basically told him to pound sand.

    And inflation is much higher than the feds let on.

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