Oil prices and interest rates, what's the link?
Hi everyone! Let me come back to my good habits and post on that group from time to time... now that I'm not working as a slave anymore (my International Economics group was great but that course was a real pain to give).
SO, there is an interesting relationship between the global price of oil and interest rates in oil-importing countries. The price of oil has increased substantially lately, which may lead to higher interest rates in a number of countries... how does it work?
First of all, we are indeed talking about a causation: higher price of oil will cause higher interest rates in these countries. The economy is fairly complicated but it's a good bet that a number of important oil-importing countries will increase their base interest rates (remember we called it the overnight rates in class) or stop decreasing them in the next few months... if everything keeps going the way it is of course.
Here's how it works: Oil and its related products are a very important part of most country's inflation levels. As such, higher oil prices normally lead to higher inflation in oil-importing countries. One of the most important roles of a country's central bank is to make sure the level of inflation is under control...
SO, higher prices of oil normally lead to higher inflation, which is something central banks don't like. One of the tools these banks have is to control the interest rates of a country (either directly through the overnight rate or by changing the money supply in a country). As such, increasing the interest rates can lead to lower economic activity (loans are more expensive and people/firms borrow less, thus buy less), which also lead to lower inflation.
Voilà! Two things that seemed completely unrelated are actually linked together through the magic of Economics!!!!!
Let me know your thoughts and/or questions and, as usual, see you guys around!