This paper investigates the relationship between energy-price shocks and three core measures of inflation in a vector autoregression model that incorporates measures of monetary policy and inflation expectations. The sample set includes data at monthly frequencies from 1980 through 2000. We find that that positive energy-price shocks have significant, though small, effects on all core price measures after a lag of 12 to 18 months, but that negative shocks have no discernable impact. The results suggest that relative energy-price changes do not distort the inflation signals that standard core-price measures provide.
If valuation ratios return to their historical means any time soon, then equity prices must fall substantially, or earnings and dividends must accelerate sharply, or some combination of these events must occur.
Many people mistakenly believe that a sharp rise in the price of energy is necessarily inflationary. They fail to understand that energy prices adjust to the demand and supply of energy, whereas inflation responds to thed emand and supply of money. This Economic Commentary explains that the Federal Reserve can do nothing about relative energy prices, but it can determine how relative energy price shocks are reflected in the overall level of prices. Over the last 20 years, the inflationary consequences of energy price shocks, while significant, have been fairly subdued.