Federal Reserve's Low Interest Rates Keep Oil Prices High

Could it be that today's monetary policies, coupled with poor domestic energy development plans, are doing more economic harm than good?

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Pete Sepp is executive vice president of the National Taxpayers Union.

It's been said that monetary policy is one of the few prescriptive remedies our leaders have at their disposal to maintain the health of the economy. Yet, behind this statement lies a great deal of controversy. The Federal Reserve's two rounds of "quantitative easing"—which have vigorously injected capital into markets—triggered concerns from some fiscal conservatives, even helping lead to legislation that would allow currencies to "compete" in setting their value. Whether or not one believes such an approach is feasible or desirable, could it be that today's monetary policies, coupled with poor domestic energy development plans, are acting as a one-two punch to aggravate our economic ailments rather than remedy them? A recent piece of expert research says "Yes."

Oil and gas are traded in the global marketplace, and therefore prices are established by international demand. As a result, oil prices and interest rates move in the opposite directions. When interest rates fall, the value of the dollar decreases. Because oil is traded in U.S. dollars, it becomes relatively cheaper for other countries, which buy more and drive up prices here at home when the dollar falls. Conversely, another way to think of it is when the strength of the dollar drops, it takes more dollars to buy the same amount of oil.

Over the last three years, the Fed has held interest rates at effectively zero percent. Those low rates encourage consumption here at home, but they make the dollar less lucrative to outside investors and end up hurting its value internationally. Earlier this year the Fed indicated it may yet consider a third round of monetary easing, which would hold interest rates at zero percent through 2014.

[See a collection of political cartoons on energy policy.]

The situation even seems self-fulfilling, in that the risk of rising gas costs on the back of the downturned economy could prompt a third round of monetary easing. This, in turn, would likely exacerbate the problem and leave the Fed with even fewer options moving forward.

In his recent paper, "The Perverse Dynamics of Long-Term Low Interest Rates: Evidence from Oil Prices," Dr. Joseph Mason, also a U.S. News Economic Intelligence contributor, addresses this phenomenon. He argues that to aid an economic recovery the Fed should focus on strengthening the dollar by increasing interest rates, and lawmakers should develop our domestic energy infrastructure to stimulate greater economic activity at home to offset short-term disruptions created by the higher interest rates. Whether or not the case for boosting interest rates is politically viable, lawmakers' willingness to pursue a robust energy policy remains a vital concern.

Dr. Mason notes in his paper that one of the chief drivers behind high oil prices is the imbalance between supply and demand. In his State of the Union Address earlier this year, the president committed himself to an "all the above" approach to energy development. Sadly, his record largely contradicts his rhetoric. The administration has hemmed and hawed over the Keystone XL pipeline, which would have increased imports from Canada; clamped down on offshore drilling sites and extended the application process to receive offshore permits; and, delayed and overregulated natural gas developments. The progress the United States has seen in energy development has come in the face of opposition from the White House, not with its help.

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

Despite the hurdles, U.S. energy development has continued to move forward. This spring the United States became a net exporter of energy for the first time since 1949; expanded shale development has driven natural gas prices to record lows; and increased domestic oil production has helped to bring crude oil prices below $90 this week, which ultimately translates into lower prices at the pump for consumers. Continuing this progress and further augmenting our energy infrastructure will ensure the long-term framework is in place to bolster the effects of a similarly foresighted monetary policy.

Instead of banking on more government intervention to push the markets back into equilibrium, lawmakers should empower domestic energy producers to develop the long-term infrastructure that will help support sustainable growth. It's time for a "quantitative easing" of a different kind—increasing affordable domestic energy to ease the way for a more robust recovery.

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