A Gloomy Economic Outlook

High oil prices to slow down growth due to boosts in interest rates to stem inflation

When oil prices started to rise in 2003, many thought that it will stabilize downward after reaching a peak. With the West Texas Intermediate as the base, oil prices rose to $40 per barrel, $50 and surpassed $60 per barrel, many experts thought that the oil market was overheated and its bubble will burst soon.
But it kept on rising contrary to projections by many oil market experts after a little pause and it still kept on climbing as of July, this year. Since 2003, the international oil prices jumped 182 percent as WTI as the base and in the case of Dubai oil, its price climbed 203 percent from $22 per barrel in 2003.
Media reports and research organizations worried that the world will face low economic growth and high stagflation due to a stall in the global economic growth caused by high oil prices and its pressure on inflation. But there still are no such signs overtly visible. The economies of advanced countries recorded sound growth in the past three years despite the gloomy predictions. The U.S. economy, in particular, has done its duty in full as a growth engine for the world in the past decade coping well with such negative factors as high oil prices with its real GDP growth surpassing its potential growth capability. The U.S. economy's potential growth rates were projected at from 2.5 percent to 3 percent in the past 10 years. Its growth rate recorded 2.7 percent in 2003, 4.2 percent in 2004, and 3.5 percent in 2005 to show that high oil prices had no impact on its economy.
The situation needs a close scrutiny whether high oil prices had not had impact on inflation at all or not because the U.S. economy overcame the situation without apparent impediment on growth.
The U.S. CPI from April, 2003 and to February this year, rose 0.16 percent on monthly average, show that high oil prices had any impact on it. Furthermore, the U.S. economy expanded 5.7 percent in the Q1 this year with CPI rising 2.7 percent during the same period, an indication high oil prices would pressure the U.S. economy to encounter stagflation was a little exaggerated. It is not difficult to find an answer to the fact that high oil prices have not had any impact on inflation in the United States because it was the U.S. monetary policies managed by the Federal Reserve Board.
Following 2003, an excessive outflow of global liquidity propped up the recovery of the world economy, generating pressure for inflation. FRB, after confirming that the world economy has entered a growth stage, it started raising Fed rates from May 2004 to preempt inflation.
The U.S. interest rate rose to 4.25 percent in the past two years, which played a great role in holding down inflationary pressure put on by high oil prices. The oil prices based on WTI climbed to $74 per barrel after June 2004, putting great pressure on inflation.
The 1970 oil shock held down economic growth and ignited stagflation due to a heavy dependence on imported oil by the U.S. and the FRB had not taken measures before hand to combat the inflationary pressure from high oil prices. Paul Volker who became FRB chairman in 1979 had done a great deal to fight stagflation and put the economy back on track for growth amid low inflation.
The problem is what will happen to oil prices down the road and its impact on the Korean economy. If oil prices reach $100 per barrel level, the FRB will boost the interest rates higher, which will lead to low economic growth to major oil importing countries. Korea will have to brace for a severe economic slowdown due to high domestic oil prices and sagging exports of its products with advanced countries experiencing sluggish economic growth. Furthermore, the rising value of the Korean currency would not be of help to efforts to soften the impact on the economy from high oil prices. Korea's domestic economy could experience a deeper stagnation than in 2003-2004 due to high oil prices. nw