The Effect of Oil Prices on Core Inflation: Recent Evidence from the Advanced Economies

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The Federal Reserve, the central bank of the United States, provides the nation with a safe, flexible, and stable monetary and financial system. Andrea De Michelis, Musa Orak,…

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Elevated oil prices and heightened geopolitical uncertainty have renewed interest in a longstanding policy question: do supply shocks like oil-price increases pose a transitory or a persistent threat to price stability? This note sheds light on this question by providing new evidence on whether the inflation process has changed. In an earlier note, De Michelis et al. (2024) documented that core inflation had become more inertial after the pandemic, implying that supply shocks might be expected to have more persistent effects if this greater inertia continued.

Because the post-pandemic period remains short, we estimate the model using a panel of five major advanced economies rather than data from a single country, which allows us to detect common shifts in persistence and pass-through more robustly. We find that the pass-through from oil prices to core inflation, which was statistically indistinguishable from zero before the pandemic, rose to an economically and statistically significant level afterwards. A horse race among nested specifications shows that allowing for stronger post-pandemic pass-through, on top of stronger persistence, delivers a marked improvement in our model's ability to track core inflation dynamics in recent years.

Admittedly, our empirical results are derived using a reduced-form approach that cannot distinguish a structural change in the underlying inflation process from the possibility that global supply shocks have become more frequent, more persistent, or both. The results presented here depend on our specification and set of controls, and different specifications might yield different results.

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