Rising oil price remain my principle concern regarding the recovery.

My thesis is that rising oil prices are a monetary contraction because the funds are just parked in T-Bills.

Imagine for example if rising oil prices caused Oil Producing countries to buy more Boeings or Catepalliar Equipment. Would we expect oil prices to be contractionary?

Or would they simply shift production away from consumption and towards exports? Economists naturally think of international trade as pure exchange but of course its not. Dollar denominated assets are accumulated. This means it has monetary effects particularly at the zero lower bound.

If we were in a normal world the appropriate response to higher oil prices would be to cut interest rates as T-Bills are seeing higher demand. Otherwise, the Fed will have to slow the growth of the money supply in order to maintain the Funds rate – which must wash with the T-Bill rate – and would otherwise fall.

However, we at the ZLB we do not have this option. We do still have the option of using the statement.

My advice would be to go with something like this

Higher oil prices represent headwinds for the US economy and may justify more accommodative action to prevent job growth from slowing.

Note that this alone will convey to markets that the higher oil goes the longer the funds rate will stay low.  This is the opposite of what they believe.

Yes, there will be freakout. Yes, people will say we are entering a new era of inflation. My advice is simply to ignore them.

A relative of mine who is a litigator often uses the phrase, “Say it with cash.”

Think of the markets as speaking with cash. The talking heads may say what they want. Even high ranking financial executives may speak out. However, if the breakevens don’t move then no one is saying it with cash and so ignore them.

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