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Kimberly Amadeo

High Gas Prices Driving Inflation

By March 22, 2012

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Inflation increased .4% during the month of February, or 2.9% year-over-year.  As you would expect, high gas prices accounted for most of the increase -- 80% of it, according to the Bureau of Labor Statistics.

What's driving gas prices? High oil prices, which are responsible for 65% of the cost of each gallon of gas. The rest is distribution costs and taxes, and they don't change very often.

What's driving oil prices? Commodities traders, who buy and sell oil futures contracts on the commodities markets. That's what makes gas and oil prices behave more like volatile stock and gold prices.

Normally, inflation is caused by one of three reasons. The most common is demand-pull inflation, which is when demand outstrips supply. A less common cause is cost-push inflation, which is when there is a sudden shortage of supply. In fact, the oil price shock in the 1970s was caused by cost-push inflation because OPEC actually limited supply. The third cause of inflation is an over-expansion of the money supply.

Today's gas and oil inflation is caused by a type of demand-pull. However, it's not demand for gasoline and oil that's driving up prices, it's demand from oil commodities traders. True, demand for gas does go up each summer, thanks to vacation driving. But that only drives up the price about 10 cents for each gallon of gas.

Commodities traders are over-reacting to fears of a oil-supply shortage that might result from a military attack on Iran. In February, Iran threatened to retaliate to any attack by blocking the Straits of Hormuz, restricting an important oil shipping lane.

Some commodities traders are industrial users of oil. They are bidding up the price of oil to make sure they have what they need in case of a shortage. Others are taking advantage of a profit opportunity -- in other words,  capitalism in action.

What It Means to You

The Energy Information Administration forecasts that oil prices will return to normal levels in April. (For more, see Oil Price Outlook.) Fortunately, the prices of other things you need -- clothing, used cars and trucks, and natural gas for heating --  dropped in February. More great news is that the cost of food and health care didn't rise at all. (Source: BLS, Consumer Price Index, March 16, 2012)

However, if gas and oil prices stay high beyond April, it could bleed into other segments of the economy. Continued high energy costs could lead to higher food prices this year.  In 2011, high food prices led to food riots and, some say, the Arab Spring. If high gas prices continue, this could lead to higher food prices, and potential unrest, later this year.

Your Opinion: What Should Be Done About High Gas Prices?

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