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February 23, 2001

An Unwelcome Surprise From the Energy Sector

For those of us who make our livings teaching principles of economics, it just doesn't get any better than this. Do you want to see supply and demand in action? Take a look at natural gas markets, particularly in energy-starved California, where rising demand and disruptions in supply have shot spot prices up to unheard of levels. Do you need a real-life example of the effect of price controls? Again, travel to the Golden State, where retail price caps have contributed to the near-bankruptcy of formerly solid utilities, and where supply disruptions are becoming appallingly common. 

But step outside the classroom and you won't find very many other people happy about the situation. Indeed, the pain that started when gasoline prices shot up last summer has only gotten worse as natural gas, propane, and electricity costs followed suit later in the year. What began as an unwelcome, but unsurprising swing in one component of transportation costs has now snowballed into a significant disruption in a much wider range of activities. And, in a manner that is eerily familiar to those who lived through the stagflation days of the 1970's, the Federal Reserve may find itself hard pressed to do anything about it.

This new concern follows the Bureau of Labor Statistic's reports of a sharp increase in both wholesale and retail prices in January. In both cases the primary culprit wasenergy costs, particularly natural gas. But the reports also show that price pressures are building across a wider range of goods and services than energy prices alone can account for. In this unhappy situation, the Fed's ability to stimulate the economy through further interest rate reductions will be significantly limited.

The January price volatility was particularly pronounced at the wholesale level. The Producer Price Index for finished goods jumped by a full 1.1 percent in a single month, the largest such gain in more than ten years. Take away the 3.8 percent gain in energy prices, mostly due to propane and natural gas, and you still have a worrisome situation. Indeed, the BLS's index that excluded both energy and food prices jumped by 0.7 percent in the first month of the year, after averaging zero growth over the last three months of 2000. 

For consumers, energy price increases were even more disruptive, although other price gains were more moderate. Were it not for the staggering 18.6 percent gain in the energy component of their market baskets, consumers would have only faced a 0.3 percent rise in prices in January, compared to their December levels. As it was, the overall index rose by 0.6 percent for the month. The evidence of inflation outside of the volatile food and energy sectors was a bit more muted at the retail level, but nonetheless remains a concern. 

The energy situation thus hovers as a wild card that provides yet another source of uncertainty in assessing the state of the U.S. economy. Although the earlier momentum in the economy was sufficient to allow it to survive a gasoline price increase with surprising ease, the pervasive use of natural gas across a wide spectrum of industries makes price increases harder to be similarly swallowed. And while the situation will probably be greatly eased in a year's time, that's scant comfort to those who are facing its disruptive influence right now.

Link to this commentary: https://commentaries.cberdata.org/486/an-unwelcome-surprise-from-the-energy-sector

Tags: finance, prices and inflation


About the Author

Pat Barkey none@example.com

Patrick Barkey is director of the University of Montana Bureau of Business and Economic Research. He has been involved with economic forecasting and health care policy research for over twenty-four years, both in the private and public sector. He served previously as Director of the Bureau of Business Research (now the Center for Business and Economic Research) at Ball State University, overseeing and participating in a wide variety of projects in labor market research and state and regional economic policy issues. He attended the University of Michigan, receiving a B.A. ('79) and Ph.D. ('86) in economics.

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