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Friday, July 1, 2011

High oil prices cause "large" effect on inflation - NZ Report

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A 2005 study by New Zealand Reserve Bank economist Felix Delbruck ("Oil prices and the New Zealand economy" - Reserve Bank of New Zealand: Bulletin, Vol. 68, No. 4) has found that the inflationary effects of higher oil prices were "quite large". Specifically that :-
  • the direct impact of a $.10c a litre increase in petrol price lead to an immediate increase in the average household's living cost of about 0.3%
  • the indirect effect (of higher bus, taxi, train and air travel, and firms passing on higher transport costs which raised the cost of food etc) added another 0.3% onto the direct effect -- a total 0.6% increase in the CPI for every $.10c a litre increase in fuel. 

At first blush a 0.6 % effect may not seem that large.  But when you consider that fuel prices have risen by 40-50 cents per litre in the past year alone, and that the Reserve Bank's target is to keep inflation between 1 - 3 %  per annum, - the 0.6% effect for every 10 cent /L increase assumes very worrying proportions.

The report compares New Zealand's oil use with that of other countries. Relative to GDP our oil use is high - closer to gas guzzling nations like the US and Canada than the OECD Europe and the UK.  Which of course leave our economy more vulnerable to inflation, plus the strongly negative impact on GDP highlighted in my post last week.

New Zealand is a relatively heavy user of transport fuel, and….
"more than in other OECD countries, our use of transport fuel is weighted towards diesel and jet fuel. This suggests that the indirect effects of higher oil prices on inflation and the economy, through an increase in the cost of providing transport services and other goods and services, may be relatively large".

The report says while the inflationary impacts are large, they may be underestimated because the calculations do not take account of the effect international oil prices have on the non-oil imports due to higher international transport costs and to the fact that overseas products for example plastics -- are more expensive.

Other "second round" effects are identified as a series of wage/price increases that leads to medium term inflation. Alternatively if wages and prices are held down, then higher oil prices mean less spending on other consumer goods and lower profits for business.

"Third round" negative impacts arising from higher oil prices identified in the report are an increase in New Zealand's imports and net foreign debt "which needs to be paid for by lower consumption and investment later on". Also higher oil prices reduce economic activities in many of our trading partners. -- reducing demand for New Zealand exports and reducing the number of inbound tourists.

In a speech to Canterbury businessman in 2010 entitled ‘Coping with Shocks - a New Zealand Perspective’ Reserve Bank Governor Alan Bollard confirmed the extent of the inflationary impact of higher oil prices identified in the Delbruck report. He stated that since 2004 around 0.5% has been added to the CPI every year due to oil price rises.


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