[stop-imf] IMF: Respond to Oil Price Hikes with Higher Interest Rates

[Robert Weissman]

http://www.financialexpress.com/fe_full_story.php?content_id=3D121303

The Financial Express <http://www.financialexpress.com/>


      * Economy*


*Hike interest rate to handle crude oil crisis, says IMF*

Economy Bureau

*New Delhi, March 22 * An International Monetary Fund (IMF) working
paper on crude oil crisis has made a strong case for tightening monetary
policy and increasing interest rates, to bring demand in line with
supply and contain inflationary effect of high oil prices.

The paper titled =93World Crude Oil Markets: Monetary Policy and the
Recent Oil Shock=94 by Noureddine Krichene stressed that tightening of
monetary policy was necessary to achieve greater energy substitution and
savings during the demand shock period. It made the suggestions while
highlighting the risk of a world economic contraction and inflation that
could be caused by high oil prices.

The oil markets remained highly volatile during 2005, and prices
followed a persistent upward trend in the midst of rising world demand
for oil, stimulated by exceptionally low interest rates and a rigid oil
supply, the paper said.

Although the oil demand is price-inelastic, it is significantly
influenced by the level of economic activity. The demand, it added, is
negatively influenced by interest rates and nominal effective exchange
rate (NEER).

The oil supply is also highly price inelastic though, =93it is strongly
co-related with the natural gas production.=94 The paper attributed
persistent oil volatility to a combination of factors including low
price, high-income elasticity, and rigid supply.

While analysing the relationship between monetary policy and oil prices,
the paper suggested that an oil demand shock, caused by record low
interest rates, led to exorbitant price increases witnessed in 2004-05.
It further added that the monetary policy, conducted through changes in
interest rates and monetary aggregates, did have a significant and
protracted effect on aggregate demand for goods and services as well as
on asset prices such as exchange rates, housing prices, and stock prices.

It further pointed out that stimulated by low interest rates and a
depreciating US dollar, demand for oil has expanded faster than the
supply. =93Given the short-run price inelasticity of both oil demand and
supply, the equilibrium is obtained through a large scale increase in
oil prices,=94 it said.

The IMF paper also drew a distinction between the supply shock and
demand shock. It added that contrary to a supply shock, where the change
in oil prices results in a pure relative price change that will help
bring about stronger energy substitution and savings, in a demand shock
most asset prices move upwards with a general increase in the price level.

Consequently, it concluded, the relative change in oil prices become
less noticeable, and therefore, the energy substitution and energy
savings effect could be less important than under a supply shock.