Costly Gasoline: Inflation Foe?

Are high energy prices actually helping to limit inflation?

Ask motorists forking out $2.79 or more per gallon at the pump and they’ll probably tell you it’s a silly question.

But some analysts suggest that costlier energy is beginning to throttle the economy, and the Federal Reserve should consider that as it continues its year-old policy of raising interest rates to curb inflation.

How can expensive energy limit inflation? It can make it harder to boost prices on other goods and services. With more of their budgets going to gasoline, consumers have less to spend on other stuff. And that means sellers must think twice before raising prices -- on products as diverse as T-shirts at Wal-Mart Stores Inc. and computers at Dell Inc. -- even if higher energy bills are driving up their costs.

By cutting into sales of gas-guzzling sport utility vehicles, higher pump prices contributed to the recent steep price discounting by the Big Three U.S. automakers, suggests John Lonski, chief economist at Moody’s Investors Service.

“That’s a prime example of where higher energy prices can rein in core [non-energy] inflation,” Lonski said.

In addition, energy price increases don’t have the same inflationary effect as two or three decades ago, in part because the economy is relatively less dependent on energy. And when adjusted for inflation, energy prices are lower than two decades ago.

Also, fiercer competition has limited businesses’ ability to raise prices.

Take airlines. Even as major carriers suffer rising fuel costs, heightened competition means “they’ve had one heck of a time raising ticket prices,” said Nariman Behravesh, chief global economist at Global Insight, an economic consulting firm in Waltham, Mass. “Every time they try to raise fares, smaller players like JetBlue or Southwest jump in and take market share.”

The upshot: “Unlike the past when oil had a huge inflationary impact, this time its inflationary impact is very small and it may have a somewhat deflationary impact,” Behravesh said.

The latest evidence of this phenomenon was seen in July’s consumer price index, released Tuesday by the Labor Department.

Although overall inflation grew by 0.5%, sparked largely by a 3.8% jump in energy, so-called core inflation -- which excludes energy and food -- rose just 0.1%.

Core inflation, in fact, has fallen from earlier this year even as oil prices have surged -- a highly unusual occurrence that can be attributed partly to low-cost imported clothing and other goods from China and elsewhere. Modest wage increases, although bad news for workers, also have reduced pressures on businesses to raise prices, some say.

“Outside of energy, we really don’t see that much inflation,” said James D. Hamilton, professor of economics at UC San Diego.

Most economists don’t think that core inflation can continue to remain at current levels because higher fuel costs eventually will push up prices of other goods and services. Indeed, core inflation at the wholesale level rose above expectations, according to Labor Department data released Wednesday. Some of that is expected to be passed to the retail level. Energy-inefficient manufacturers, for example, might be forced to cut production or shut down.

“That will enhance the pricing power of remaining producers,” Lonski said.

But rises in core inflation at the retail level won’t be dramatic, he said.

If so, there will be less pressure on the Fed to prolong its credit tightening, analysts say. Rising energy prices, they say, already are helping the Fed do its job, acting in concert with higher interest rates to slow the economy and curb inflation. As much as half of the decrease in annualized U.S. economic growth, from 4.2% last year to 3.4% in the second quarter, can be attributed to higher energy costs, Behravesh said.

Raise interest rates too much -- without any significant relief in energy prices -- and the Fed risks slowing the economy even further.

Except for the 1960 downturn, every postwar U.S. recession has been preceded by a jump in energy prices, Hamilton said.

High energy costs haven’t already created a serious slowdown largely because interest rates are still low by historic standards. In today’s service-oriented economy, easy credit overrides the effect of higher energy bills.

Low mortgage rates, for example, have helped push home prices through the roof, giving many consumers an added sense of wealth. And some consumers are eagerly drawing on low-cost home equity loans to finance their European vacations or new Toyotas.

But consumers -- particularly lower-income households lacking home equity -- are becoming more hesitant to boost their spending.

Just ask Wal-Mart. The giant retailer said Tuesday that high energy costs were cutting into consumer spending, forcing it to cut profit projections for the remainder of this year.

“Unless energy prices ease, the holiday shopping season will probably be mediocre at best,” Lonski said.

“Consumers will have to curb their spending eventually, which would help to cool economic growth,” Bob Doll, chief investment officer at Merrill Lynch Investment Managers, said in a recent report. Doll expects higher energy prices, rising interest rates and a rebounding dollar will to slow economic growth later this year.

If that happens, the Fed may think twice about raising interest rates a lot more, experts say.

“The Fed does not want to create a recession,” said Hamilton, the UC San Diego professor.