Oil Shocks Can't Cause Broad Inflation (On Their Own)

When oil prices spike, that causes inflation — right?

It's one of those things that feels so obviously true that nobody questions it. Oil goes up, gas goes up, shipping goes up, groceries go up, and before long everything costs more. You've heard this story a thousand times. Every news cycle that includes the words “oil prices” and “inflation” treats them as cause and effect, as natural as rain and wet ground.

But there's a problem with this story. Think about how your household budget actually works, and the whole thing falls apart.

The thought experiment

Think about your monthly budget as a fixed pool of money. You earn what you earn. Now imagine gasoline prices double overnight. Your commute to work just got a lot more expensive — maybe $200 more per month.

Where does that $200 come from?

It comes out of everything else. You eat out less. You cancel a streaming subscription. You postpone the new TV. You skip the weekend trip. Your total budget hasn't changed — you didn't get a raise because gas went up. You just spend more on fuel and less on everything else.

Now multiply that across every household in the country. Millions of people shift their spending toward gasoline and away from restaurants, entertainment, retail, and travel. Demand for those other categories drops. And when demand drops, prices in those categories fall — or at least rise more slowly than they otherwise would.

The composition of spending has changed. The total hasn't. Some things cost more; other things cost less. On average, the price level is roughly where it was.

This is called a relative price change. One category goes up, others adjust down. It's a reshuffling of spending, not a broad increase in prices across the entire economy.

The same logic everywhere

The logic isn't limited to oil. It applies to anything that makes one category of spending more expensive without putting more money into the economy.

Tariffs raise the price of imported goods. But a tariff doesn't put more money in your pocket. If you're paying more for imported steel or electronics, you're paying less for something else. The tariff reshuffles your spending; it doesn't create new spending.

A bad harvest drives up wheat prices. Bread gets expensive. But the bad harvest didn't print new dollars. Families buy less of other things to afford the bread. Demand shifts; the average price level doesn't move much.

A supply chain disruption raises the cost of lumber or semiconductors. The affected goods get expensive. But the disruption didn't increase anyone's income. People adjust by spending less elsewhere.

In every case, the mechanism is the same: a price spike in one area means less spending in another area. It's a zero-sum redistribution, not inflation.

So what is inflation?

If a relative price change isn't inflation, what is?

Inflation — real, broad, sustained inflation — is when most prices across the economy rise at roughly the same time, and the increase persists rather than reversing. Your groceries cost more. Your rent costs more. Your haircut costs more. Your insurance costs more. Not just one of them — nearly all of them, steadily, year after year.

For that to happen, there has to be more money in the system. Households need more dollars to spend so they can pay higher prices across the board without cutting back on anything. If total spending stays the same, price increases in one place have to be offset by decreases somewhere else. That's just arithmetic.

The only way every price goes up at the same time is if the total pool of money chasing goods and services has grown. And the only institution that controls the size of that pool is the central bank.

This is the distinction that matters. One category up, others down or flat: that's a relative price change. Most categories up, sustained over time: that's broad inflation. Only one of these two requires the money supply to grow. And only the second one is what the word “inflation” actually means.

“But what about the 1970s?”

If you've read this far and you're skeptical, you're probably thinking about the 1970s. Two massive oil shocks — the 1973 OPEC embargo and the 1979 Iranian Revolution — coincided with the worst inflation the United States had experienced since World War II. CPI inflation peaked at 14.8% in March 1980. Surely that proves oil shocks cause inflation?

It's the strongest possible objection to the argument I'm making. So let's look at what actually happened.

The timeline matters. Before the first oil shock hit in October 1973, the U.S. money supply had already been growing rapidly for years. The Federal Reserve under Chairman Arthur Burns had been running easy monetary policy through the late 1960s and early 1970s — partly under direct political pressure from President Nixon, who wanted loose money ahead of the 1972 election. (This isn't speculation; Burns' published diaries and the Nixon White House tapes both document the pressure and his compliance.)

Then, in August 1971, Nixon ended the dollar's convertibility to gold under the Bretton Woods system. This removed the last external constraint on U.S. monetary expansion. The money supply was free to grow as fast as the Fed would allow — and it did.

By the time OPEC raised oil prices in late 1973, the conditions for broad inflation were already in place. The money supply had been expanding for years. The gold constraint was gone. The monetary fuel was sitting there, waiting for a spark.

The oil shock was the spark. It turned latent monetary inflation into visible consumer inflation. But the oil wasn't the cause — any more than a match is the cause of a house fire when the house is soaked in gasoline.

Here's the test: if oil shocks alone could cause broad inflation, then the same oil shocks in a country with tight monetary policy would have produced the same inflation. They didn't. Countries that maintained tighter monetary discipline experienced the oil shock as exactly what the theory predicts — a relative price change and a recession, not a sustained broad inflation.

And here's the part that should settle it: the Federal Reserve's own published history of “The Great Inflation” attributes the inflation primarily to the Fed's own policy errors — running easy monetary policy in pursuit of low unemployment based on a misread of the Phillips curve — and treats the oil shocks as accelerants, not causes.

When the institution responsible for the inflation acknowledges that it was responsible for the inflation, the oil-shock story starts to look like what it is: a convenient misdirection.

The takeaway

A price shock in one area means less spending somewhere else. Not inflation.

To get broad inflation — the kind where everything costs more, year after year, and the dollar in your pocket buys less of nearly everything — you need more money in the system. There is no shortcut through oil shocks, tariffs, supply chains, or bad harvests. Those are real disruptions that cause real pain, but they are not the same thing as inflation, and calling them inflation obscures the actual cause.

The next time someone tells you that rising oil prices are “causing inflation,” ask a simple question: where's the extra money coming from? If the answer is “nowhere — people are just paying more for gas and less for other things,” then what you're looking at isn't inflation. It's a reshuffling. And the distinction matters, because if you misidentify the cause, you'll never understand the cure.

That leads to the next question: if supply shocks aren't the cause of broad inflation, what is? The answer involves one equation, one uncomfortable fact about technology, and a policy choice that almost nobody knows was made in a TV interview in 1989.

That's Part 2.