The Boston Fed’s statistical modeling suggests that a $ increase in the price of a barrel of oil will shave roughly four-tenths of a percentage point off the rate of economic growth over two years, and cause the unemployment rate to be roughly two-tenths of a percentage point higher than it would be absent the oil shock. While this is certainly not enough to completely stop the recovery, it does imply a slowing down of its pace. Oil is not the only commodity to experience price increases of late. A variety of agricultural prices have also increased. For example, Figure 3 shows the movement of wheat prices over the last decade. Droughts in Russia, flooding in Australia, and increased demand in emerging markets have all placed upward pressure on wheat prices. As with oil prices, higher food prices appear to be responding to supply and demand features of this market – and these types of price changes cannot be offset by monetary policy. It goes without saying that monetary policy cannot alter the supply of oil from volatile parts of the world, nor weather conditions in countries that are major exporters of agricultural products. Monetary policy can have a role in insuring that relative price changes do not alter inflation expectations. Rising inflation expectations could make it difficult to achieve a moderate and acceptable inflation rate over the medium term. Historical experience with supply shocks Supply shocks are not unique to this period.
Consequently, longer-term inflation expectations became unmoored, and nominal wages and prices spiraled upward as workers sought compensation for past price increases and as firms responded to accelerating labor costs with further increases in prices. That wage-price spiral was eventually arrested by the Federal Reserve under Chairman Paul Volcker, but only at the cost of a severe recession in the early 1980s. Since then the Federal Reserve has remained determined to avoid these mistakes and to keep inflation low and stable.” [http://www.federalreserve.gov/newsevents/speech/yellen20110411a.htm]  BIS central bankers’ speeches  5  Figure 15 shows two measures of inflation expectations, plotted alongside oil price movements. The red line shows what professional forecasters expected inflation to average over the next 10 years, at various points in time. Their expectations have declined somewhat over the past 20 years, but what is striking is the relative stability of their inflation expectations. In addition, there was no significant reaction to the oil price shock that we experienced in 2008. The chart also shows a second measure of inflation expectations – the University of Michigan Survey (the green line), which asks respondents about their expectations for inflation over the next 5 to 10 years.6 Again these expectations are not very responsive to movements in oil prices, and have remained quite stable over the past two decades. It is worth noting that countries can be affected quite differently by supply shocks. As Figure 16 shows, the importance of food in the “basket” of goods purchased by consumers can vary greatly by country.