Monetary Policy and Oil Prices: A New Paradigm?

Philipp Hildebrand, Member of the Governing Board

Swiss-American Chamber of Commerce, New York, 18.11.2004

Oil price developments in 2004 bring back painful memories of the oil shocks during the 1970s. However, respective oil price increases are not comparable in real terms and inflation expectations are currently well anchored. Nonetheless, several factors support the hypothesis of an upward shift in oil price levels as observed in long-dated oil futures contracts: the integration of large oil importing countries into the world economy, low oil inventories, inadequate investments in the oil supply chain, and the role of oil as a financial asset class. Compared to past decades, the pass-through of changing oil prices into headline inflation appears to occur at a more rapid pace. At the same time, the magnitude of the pass-through seems to be less pronounced because of globalization pressures, decreased oil dependency and central banks firmly committed to price stability. For monetary policy, core inflation measures are important because they indicate potential second-round effects due to changed wage- and price-setting behavior. Currently, inflation appears to be contained in Switzerland and elsewhere. As long as longer-term inflation expectations are firmly anchored, monetary policy can afford to “look through” the temporary rise in headline inflation. Going forward, the key challenge for monetary policy authorities will be to continue to firmly anchor these longer-term inflation expectations. The Swiss National Bank would promptly react if there were any indications that second-round effects were likely to undermine its long-term track record of maintaining price stability.