Boston Fed paper: Fed should focus on inflation risks amid energy crisis

New research by the Federal Reserve Bank of Boston suggests that a change in the way Americans use energy could allow the Federal Reserve to concentrate monetary policy decisions on the inflationary effects of the Middle East oil price shock.

In a report published on Thursday, economists at a bank said that U.S. exposure to global economic growth has changed "fundamentally", since the 1970s. This is due to increased energy efficiency and domestic production.

These changes mean an increase in oil prices has less of an impact than it did before. In the meantime, the increased production of domestic energy means that higher prices are able to spur employment, and offset the job losses in the sector that would have occurred in the past.

The job market is less affected by the energy crisis, which would normally lead to a large number of job losses. This would also reduce the impact on inflation.

The economists concluded that "the U.S.'s economy's vulnerability to shocks from oil has fundamentally changed. It has not been eliminated, but rather reconfigured." These findings suggest that monetary policies should be more focused on the inflationary effects of oil shocks, rather than the employment effects.

The paper stated that although the current shock was notable, it had a smaller economic impact than either the 1973-1974 OPEC Oil Embargo or the 1978-1980 Iranian Revolution. The authors said that "the diminished aggregate employment impacts of oil shocks decrease the likelihood of'stagflation style tradeoffs between unemployment and inflation which characterized the 1970s."

The Boston Fed paper came out as Fed officials struggled to decide the future of monetary policy. The Fed will meet on 16-17 June in a meeting where policymakers are almost certain to maintain their 'interest rate target range' between 3.50% - 3.75%.

Officials are trying determine if the increase in inflation pressures caused by the U.S. and Israeli war against Iran will have to be tempered with a tighter monetary policies. Officials are largely in favor of keeping rates steady, while they wait to see what the long-term impact of the war will be on price pressures.

The longer war continues, the more likely it is that inflation will continue to be high. It has been consistently above the Fed's 2% target over the years.

Fed officials are speculating that interest rates may need to be raised later this year, if inflation doesn't start to ease. Boston Fed research indicates that such a path would not likely lead to significant job market problems. (Reporting and editing by Andrea Ricci; Reporting by Michael S. Derby)

(source: Reuters)