A:

The price of oil and inflation are often seen as being connected in a cause and effect relationship. As oil prices move up or down, inflation follows in the same direction. The reason why this happens is that oil is a major input in the economy - it is used in critical activities such as fueling transportation and heating homes - and if input costs rise, so should the cost of end products. For example, if the price of oil rises, then it will cost more to make plastic, and a plastics company will then pass on some or all of this cost to the consumer, which raises prices and thus inflation.

The direct relationship between oil and inflation was evident in the 1970s, when the cost of oil rose from a nominal price of $3 before the 1973 oil crisis to around $40 during the 1979 oil crisis. This helped cause the consumer price index (CPI), a key measure of inflation, to more than double from 41.20 in early 1972 to 86.30 by the end of 1980. Let's put this into perspective: while it had previously taken 24 years (1947-1971) for the CPI to double, during the 1970s it took about eight years.

However, this relationship between oil and inflation started to deteriorate after the 1980s. During the 1990's Gulf War oil crisis, crude prices doubled in six months from around $20 to around $40, but CPI remained relatively stable, growing from 134.6 in January 1991 to 137.9 in December 1991. This detachment in the relationship was even more apparent during the oil price run-up from 1999 to 2005, in which the annual average nominal price of oil rose from $16.56 to $50.04. During this same period, the CPI rose from 164.30 in January 1999 to 196.80 in December 2005. Judging by this data, it appears that the strong correlation between oil prices and inflation that was seen in the 1970s has weakened significantly.

For more information, see our Inflation tutorial and The Consumer Price Index: A Friend To Investors.

RELATED FAQS
  1. Why do oil stock prices drop?

    Doesn't lower oil prices mean more profit for companies that use oil products?  ... Read Answer >>
  2. When you buy oil, do you have to buy thousands of stocks at one time or can you start ...

    I am new to oil stocks and want to invest a couple thousand dollars. Do oil stocks pay dividends? Is now the time to ... Read Answer >>
  3. I heard that if the price of oil is low that means the stock market is not doing ...

  4. How does the price of oil affect the stock market?

    Read about how the price of oil might impact the stock market and why economists have not been able to find a strong correlation ... Read Answer >>
  5. Why are stocks and oil so correlated right now?

    Learn whether the stock market and oil prices will continue their highly correlated price relationship or decouple again ... Read Answer >>
  6. What causes oil prices to fluctuate?

    Discover how OPEC, demand and supply, natural disasters, production costs and political instability are some of the major ... Read Answer >>
Related Articles
  1. Markets

    Who Wins With Low Energy Prices? 

    Low oil prices are here to stay for some time. Which economies will benefit or lose from the low oil price regime?
  2. Markets

    How Oil Prices Impact the U.S. Economy

    Now that the United States has increased oil production through shale oil and fracking, low oil prices can harm the U.S. oil industry and its workers.
  3. Markets

    Oil Boom 2.0: Be Sure You Are Ready to Invest

    Learn about the potential for oil boom 2.0, and discover why some experts say this is a good time to invest in oil companies and ETFs.
  4. Trading

    How Does Crude Oil Affect Gas Prices?

    Find out how this commodity's fluctuating price affects more than just how much you pay at the pump.
  5. Markets

    Who is Most Affected by Lower Oil Prices?

    With low oil prices affecting just about everyone, from citizens to corporations to entire nations, we look at who wins and who loses with the price drop.
  6. Markets

    Peak Oil: What To Do When The Wells Run Dry

    Find out how to invest and protect your investments in this slippery sector.
  7. Investing

    Investing in Oil Stocks vs. Oil Companies: What's the Difference? (USO)

    Learn about the major advantages, disadvantages and risks of investing in oil companies and investing in oil and gas exploration companies.
  8. ETFs & Mutual Funds

    Take Advantage of Cheap Oil, Invest in these ETFs

    With crude oil prices at record lows, investors should consider oil ETFs over oil company stocks as ETFs more closely mirror the price of oil
  9. Markets

    Is Now the Right Time to Buy Oil Stocks?

    Learn about the oil industry and how crude oil effects the prices of oil stock. Understand if now is a good time to purchase oil stock.
  10. Markets

    Oil Prices Expected to Surge in 2017

    Oil has made headlines for its plummeting prices this year. When will prices rise again?
RELATED TERMS
  1. Oil ETF

    A category of exchange-traded funds that invest in companies ...
  2. Crude Oil

    Crude oil is a naturally occurring, unrefined petroleum product ...
  3. Unconventional Oil

    A type of petroleum that is produced or obtained through techniques ...
  4. Initial Production

    The measurement of an oil well's production at the outset. Initial ...
  5. Oil Refinery

    An industrial plant that refines crude oil into petroleum products ...
  6. Inflation Trade

    A method of investing that seeks to profit from an overall increase ...
Hot Definitions
  1. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  2. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  3. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  4. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  5. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
  6. Omnibus Account

    An account between two futures merchants (brokers). It involves the transaction of individual accounts which are combined ...
Trading Center