How Barack Obama's Fed Policy Fuels the Oil Shock

The inflationary bias in Fed policy, combined with a lack of investment in energy infrastructure, is helping to keep oil prices high.

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Joseph Mason is the Moyse/LBA Chair of Banking at the Ourso School of Business at Louisiana State University and a senior fellow at the Wharton School of the University of Pennsylvania.

The Federal Reserve met last month to discuss its economic outlook. And though the Fed didn't announce a formal third round of quantitative easing, Chairman Ben Bernanke confirmed the zero-bound interest rate policy will continue into the near future. What is interesting to note—and underreported—is the impact this will have on oil prices.

While multiple factors contribute to rising oil and gasoline prices, the inflationary bias in Fed policy, combined with a lack of investment in energy infrastructure, is helping to keep oil prices high. This is a mechanism I analyze in my new paper for the Small Business & Entrepreneurship Council, "Monetary Policy, Gas Prices and the Impact on Small Businesses."

Two major theories help to explain this phenomenon: the Frankel hypothesis and the "Dollar Bloc" argument. The Frankel hypothesis concludes that low interest rates serve as a disincentive for domestic production. The "Dollar Bloc" argument stipulates that low interest rates incentivize firms to move domestic production abroad. Add to that effect threatened U.S. tax policies, drilling restrictions, and inadequate crude oil distribution infrastructure, and you have a clear incentive to move production abroad precisely at the time we need U.S. economic growth at home.

[See a collection of political cartoons on gas prices.]

The important takeaway is that oil prices are not exogenous to monetary policy; to the contrary, they are quite sensitive to them.

Yet the Obama administration continues to deny its role in the ongoing oil shock. On March 17, President Obama attempted to distance himself from his influence on gas prices, stating, "The price of gas depends on a lot of factors that are often beyond our control. Unrest in the Middle East can tighten global oil supply. Growing nations like China or India adding car to the road increases demand." And lately he's been blaming speculators for the volatility in global oil markets.

While the president's assertion that "there are no quick fixes to this problem" is correct, three years have passed without a policy response. To date, American producers are limited by several restrictions: the moratorium on several areas of offshore drilling (Alaska, east and west coasts), uncertainty in taxation policies, and energy infrastructure shortfalls.

And without a strategy forward, the U.S. monetary policy will continue to hurt Americans at the pump and hinder U.S. growth and competitiveness.

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