The new administration’s push to increase oil production, often referred to as the "drill, baby, drill" approach, aims to lower inflation in a high-interest rate environment. With rising costs and supply chain issues still affecting businesses, it’s crucial to understand how this strategy might impact the economy based on past results. Sharing these insights helps clients anticipate potential changes and make informed decisions.
Demand-Pull Inflation: A Spending Surge
After the pandemic, recovery policies like stimulus payments and low interest rates led to a sharp rise in consumer spending. Demand for goods and services grew so quickly that supply chains struggled to keep up. As lockdowns ended, people’s eagerness to travel, buy durable goods, and dine out added more pressure, driving up prices.
Cost-Push Inflation: Supply Chain Disruptions
Global supply chain disruptions, worsened by events like Russia’s invasion of Ukraine, have led to major shortages in energy, food, and essential manufacturing materials. Oil prices surged as sanctions and reduced exports from Russia tightened global supply. At home, limited drilling permits, reduced refining capacity, and delays in energy infrastructure projects—along with strict environmental regulations—further added to rising energy costs.
A Dual Pressure
The combination of high demand and limited supply created a unique inflationary pressure. Strong demand kept people spending, while supply chain issues, regulations, and rising inflation expectations pushed costs even higher. This cycle reinforced itself, making the impact on prices even more severe.
Lessons from History: The 1970s Oil Crisis
The economic struggles of the 1970s offer important lessons. In 1973, OPEC’s oil embargo caused energy prices to soar, leading to rising costs across the board (cost-push inflation). At home, price controls on oil reduced production and made shortages worse. Another major oil crisis hit in 1979 after the Iranian Revolution, driving prices higher again, which fueled inflation and slowed the economy even more.
What Worked Then and What Could Work Now?
In the 1980s, two key strategies were implemented to combat inflation:
Raising Interest Rates
The Federal Reserve increased rates to curb demand-pull inflation. While effective, this approach caused a recession as consumer spending and investment slowed. Today, with interest rates already high, further hikes carry the risk of economic stagnation.Increasing Oil Production
Expanding oil supply, through projects like the Alaskan pipeline, helped stabilize energy prices. However, this solution requires significant time and investment. Delays caused by domestic policy or geopolitical instability can reduce its effectiveness as a short-term strategy.
The Path Forward
With interest rates already high, increasing energy supply offers a practical way to tackle inflation driven by rising costs. Policymakers could focus on cutting red tape, supporting energy infrastructure projects, and encouraging domestic production to help ease economic pressures. While combining strategies that address both supply and demand has worked well in the past, today’s challenges call for a more focused plan that prioritizes energy solutions.