Why do you think the surge in oil prices in 20072008 had a much smaller impact o
ID: 2797480 • Letter: W
Question
Why do you think the surge in oil prices in 20072008 had a much smaller impact on inflation expectations compared with the oil price shocks of the 1970s?
revised: jrl 05-17-2011
A. The response of inflation expectations to changes in economic conditions depends to a large extent on the credibility of the monetary policymaker, and the smaller impact of the 20072008 surge in oil prices compared with the 1970s likely reflects the greater credibility of the central bank in the later period. Because inflationary expectations were well-anchored, transitory changes in input costs did not undermine expectations.
B. The response of inflation expectations to changes in economic conditions depends to a large extent on the credibility of the monetary policymaker, and the smaller impact of the 20072008 surge in oil prices compared with the 1970s likely reflects the greater credibility of the central bank in the 1970s. Because of this credibility, people felt more comfortable adjusting their expectations in response to the oil shocks.
C. During the 20072008 period, people were just too distracted by other developments to even notice that oil prices had risen and that was the only reason inflationary expectations did not adjust to the extent they did in the 1970s.
D. The smaller response of inflationary expectations in 20072008 compared with the 1970s is simply random.
Explanation / Answer
A. The response of inflation expectations to changes in economic conditions depends to a large extent on the credibility of the monetary policymaker, and the smaller impact of the 20072008 surge in oil prices compared with the 1970s likely reflects the greater credibility of the central bank in the later period. Because inflationary expectations were well-anchored, transitory changes in input costs did not undermine expectations.
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