Russia’s military threat to Ukraine has brought terror to the region and destabilized global energy markets.
Already facing 40% more expensive gasoline since January, American motorists will find no comfort now, as crude oil prices break $90 a barrel and, in the last few days, have touched $100 in spot markets. What else might the conflict portend for the U.S. economy? How does this all relate to the ongoing struggle by the Federal Reserve to hammer down inflation? Our central bankers were already in the process of slowing U.S. economic activity. Won’t rising energy prices confound the Federal Reserve’s efforts?
To address these questions, we must first recognize that Russia produces 10% of the world’s petroleum output. Moscow is the major supplier of coal, oil, and natural gas to European consumers. While there are always second- and third-best suppliers, conflict-induced disturbances of normal supply lines impose meaningful costs to consumers — not just in Europe but worldwide. Those costs seem destined to rise further in the weeks ahead.
We in the United States should not be surprised to see the price per gallon of gasoline rise from the current average of $3.53 to somewhere in the neighborhood of $4.00 in the next few days. Needless to say, shelling out $100 to fill the tank of the family SUV will put more than just a crimp in the family budget. Carpooling and use of public transportation may very well become more popular.
As for the Federal Reserve, it’s already committed to hitting the interest rate brake pedal to take inflationary steam from the economy. It’s finally admitted something that most observers had either believed from the beginning or come to accept: The systematic increases in the price level of all goods taken together is not something that is just passing through. Prior to the Ukraine tragedy, the central bank was expected to bring about multiple interest rate increases starting in March and going forward in the year ahead.
Taking actions to decelerate an economy is a highly uncertain process. After all, the U.S. economy is not like a smartphone with multiple buttons and dials that can be moved with precision. For central bankers, and more importantly, consumers, the risk of hitting the interest rate brakes too hard or too often could eventually be seen in the onset of a recession. While there is no evidence now of a lurking recession, the possibility has at least become more real.
COVID-19 and the remedies taken to soften its blows had already made the Federal Reserve’s job unduly complicated. The Ukraine crisis and rising energy prices add another shot of difficulty. As the Federal Reserve plans and attempts to deal with these complications, we should recognize that rising gasoline prices will make CPI-measured inflation head skyward. We should also note that observing a rising price for one commodity and trying to deal with it is a distinctly different matter from responding to situations where almost all prices are rising together. The central bank now finds itself in the unfortunate position of threading a monetary needle at a time when an error made in slowing the economy too much will be magnified by the slowing effects of higher-priced energy.
This situation is fluid, but the Federal Reserve should not hit the economic brakes harder than it planned in the face of Ukraine-induced, higher-priced energy. Indeed, it is more important than ever for Federal Reserve officials to keep an eye on the longer-run prize, which is subdued inflation without a screeching halt for the economy.
Bruce Yandle is a distinguished adjunct fellow with the Mercatus Center at George Mason University, dean emeritus of the Clemson College of Business and Behavioral Sciences, and a former executive director of the Federal Trade Commission.
