News Release
Speech by David Walton
Has Oil Lost the Capacity To Shock?
23 February 2006
Speaking at the University of Warwick Graduates’ Association
Senior Directors’ Forum, David Walton, member of the Monetary
Policy Committee, said that the UK economy appears to have emerged
relatively unscathed from a doubling in oil prices since the
end of 2003.
For Mr Walton, in explaining this fairly benign outcome relative
to previous episodes of rising oil prices, “the size and
nature of the oil price shock are important. But so too are
the mechanisms by which the shock gets propagated through the
economy. Among other things, this depends on the state of the
economy at the time the shock hits, the extent of rigidities
in the economy, the monetary policy framework and the monetary
policy response.”
After considering each of these in turn, Mr Walton reaches several
conclusions.
“The size and nature of the shock have been different.
Relative to previous episodes, the shock has taken longer to
unfold. The economy is also less dependent on oil than during
the 1970s. And oil prices have risen as a consequence of strong
global demand rather than as a result of supply disruptions
associated with wars.”
“The UK economy has been better placed to absorb the current oil price shock. There were few inflationary pressures in the economy when oil prices first began to rise sharply and there has been little sign subsequently of higher wage demands.”
“The monetary policy framework has played an important role. Inflation targeting has helped to anchor inflation expectations, yet it has allowed the MPC to respond flexibly to the oil shock.”
Mr Walton also argues that this episode has provided important
lessons for the conduct of monetary policy. “An oil shock
can have effects on supply and demand in the economy, both in
the short run and the long run. It is the balance between supply
and demand that matters most for inflation and,
hence, interest rates. But the magnitude and timing of these
demand and supply effects are very hard to determine. There
is no mechanical formula that can be applied to tell the MPC
how to adjust interest rates to deal with higher oil prices.”
Reflecting on recent interest rate considerations, Mr Walton
said: “With inflation expectations remaining stable, the
MPC did not have to respond directly to the first round effects
of higher oil prices on consumer price inflation. The MPC was
able instead to pay more attention initially to the negative
consequences for demand. But the Committee also needs to watch
carefully for any signs of an adverse impact on supply, particularly
now that GDP growth appears to have returned to around its long-run
average rate. And we do not yet know how large the shock will
be ultimately. After dipping during the final months of last
year, oil prices have been rising again in recent weeks; wholesale
gas prices have also risen sharply. At all times, the Committee’s
focus will be on achieving the appropriate balance between demand
and supply to keep consumer price inflation on track to hit
the government’s target of 2 per cent.”
Key Resources
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“Has Oil Lost the Capacity to Shock?” Speech by David Walton to the University of Warwick Graduates' Association Senior Directors' Forum in London on 23 February 2006 Download PDF (230k) |
