Is Wall Street misreading the inflation signal?
A growing consensus across financial markets holds that surging energy costs are the primary force behind recent inflation. However, a prominent academic voice is pushing back, arguing that oil prices not driving inflation is a more accurate interpretation of current economic dynamics.
Following the latest consumer price index data showing a 3.3% annual increase in March, many analysts quickly attributed the rise to higher crude prices tied to geopolitical tensions in the Middle East. The disruption of key shipping routes has pushed fuel costs higher, reinforcing the belief that inflation will ease once oil markets stabilize.
Yet Steve Hanke, a professor of applied economics at Johns Hopkins University, challenges that narrative. He argues that the apparent link between oil and inflation is largely coincidental rather than causal.
“Oil prices and inflation often move together, but that does not mean one causes the other,” Hanke has consistently maintained in his research and commentary.
The monetarist case, “Inflation starts with money”
Hanke’s argument centers on a long-standing principle in economics: inflation is fundamentally a monetary phenomenon. According to his analysis, the true driver behind rising prices is the expansion of the money supply, not temporary shocks in commodity markets.
He points out that inflation was already accelerating before recent geopolitical disruptions. Data from earlier in the year showed similar inflation rates, suggesting that underlying forces were already at work.
From this perspective, rising energy prices simply shift spending patterns. When households spend more on fuel, they reduce expenditures elsewhere, leaving the overall price level largely unaffected. What changes are relative prices, not aggregate inflation.
Hanke emphasizes that commercial banks play a dominant role in this process. By expanding lending, banks effectively increase the money circulating in the economy. He estimates that banks account for roughly 80% of new money creation, with central banks contributing the remainder.
Recent data shows a notable rebound in bank lending growth after a period of contraction in 2023. That reversal, he argues, is now feeding through to higher prices, consistent with the lagged effects typically seen in monetary policy.
A lesson from history, Japan’s counterintuitive outcome
Can oil shocks exist without inflation?
To support his argument, Hanke points to historical examples that challenge conventional thinking. One of the most notable cases comes from Japan during the 1970s.
During the global oil crisis triggered by the Yom Kippur War, inflation surged dramatically across many economies. In Japan, consumer prices spiked sharply, reinforcing the widely held belief that oil shocks directly drive inflation.
However, Hanke argues that the groundwork had been laid earlier. The Bank of Japan had significantly expanded the money supply in the early 1970s. When the central bank later tightened monetary policy, inflation began to fall, even as oil prices remained volatile.
By the late 1970s, Japan managed to contain inflation despite another surge in oil prices following the Iranian Revolution. According to Hanke, this outcome demonstrates that disciplined monetary policy can offset external price shocks.
What this means for today’s economy
If not oil, what keeps inflation elevated?
The implication of Hanke’s view is significant for policymakers and investors alike. If oil prices not driving inflation holds true, then expectations of a rapid decline in inflation following geopolitical stabilization may be misplaced.
Instead, the trajectory of inflation will depend more heavily on credit conditions and money supply growth. The recent expansion in bank lending suggests that inflationary pressures could persist even if energy prices retreat.
This perspective also reframes the role of central banks. While interest rate adjustments remain important, monitoring broader monetary aggregates becomes critical in understanding future inflation trends.
For markets, the takeaway is clear. Short-term fluctuations in commodity prices may capture headlines, but the deeper forces shaping inflation operate on longer timelines and are rooted in financial system dynamics.
As the current cycle unfolds, the debate between commodity-driven and monetary explanations is likely to intensify. For now, Hanke’s contrarian stance serves as a reminder that widely accepted narratives in economics are not always correct, especially when they overlook the underlying mechanics of money itself.
