One economic opinion argues that rising oil prices do not cause consumer price inflation in the short to medium term. Its reasons that consumers’ incomes are fixed in the short term and, as such, are distributed (spent) among a variety (basket) of goods and services.
Therefore, as the price of one essential and necessary item rises, the consumer is forced to allocate a bigger portion of his income to that item and less to others (subject to all other things being equal). This reduces demand on the other items, and forces their suppliers to reduce their prices – technically, the Demand curve shifts to the left.
Of course, in the longer term, suppliers will adjust their operations (and Supply curves) to meet this changed demand. But in the short term, the impact would be deflationary on some items, which tends to balance out the inflationary impact of the rise in the price of one or few items.
This has been empirically demonstrated in a series of graphs for oil price changes over twelve years (2005 – 2017). The US Consumer Price Index was plotted against the changes in oil prices, and it clearly illustrates the time lag between them. The trend in most cases is for the oil price to rise to be later followed by consumer price inflation, and vice versa.
What Does Increase Inflation?
In view of the fact that people’s incomes are fixed in the short term, as well as suppliers ability to increase or decrease their production or inventories, the only way, in the above case, that inflation can creep into the short term is for the money supply to increase.
Once money supply is increased by via central bank monetary policies and commercial banks’ loans, consumers receive more money to spend to maintain their previous level of consumption, thus pressuring all prices to rise.
The negative aspect of such an increase in money supply is that there is no incentive for the consumers to do their homework and think hard about their consumption patterns and choices. They do not need to vote with their pockets and send the necessary signals to suppliers, who, in turn, are not induced to adjust and improve their production patterns. And that, is the road to “exuberant consumption” and economic bubbles.
The Second Cause of Inflation in Kuwait and the Gulf
The Gulf states are predominantly paternalistic economies, who provide the income of the vast majority of their citizens, expatriates and private sector. Also, a big part of those economies is non-productive in the sense of not providing government independent products and services, those that can be exported, or at least replace the mountain of imports, which is the main source of consumer price inflation (Imported Inflation).
The paternalistic policies of the Gulf governments act as a second cause of inflation. For, in addition to excessive government projects and purchases awarded to the private sector, these governments maintain huge civil services far greater than their actual work needs, pay them excellent salaries and benefits with generous annual raises, and regularly grant the population monetary gifts. To top it up, the governments also absorb part of their citizens’ normal living expenses through various subsidies programs. They, thus, contribute to the increase of money supply and unwittingly encourage inflation.
It is the deflationary conditions in the world, since the great financial crisis of 2008/9, that have kept local inflation in the 3 – 4% range. Had things been normal worldwide, we may have witnessed local inflation in double digits. This could still happen, and if it does, what would the governments do? Especially, when they no longer have the bountiful oil revenue they once had?
There are several possible paths out of this predicament. They center around wisely addressing the governments bloated budgets, the restructuring of the civil service, creating new sources of foreign income and, of course reigning in runaway consumption. However, these are longer term solutions, that require time and money. So, the sooner the governments realize this, and stop wasting precious and expensive time, the sooner are we likely to get our ship on even keel and, hopefully survive the coming storm.