Oil Prices, Gasoline Prices and Inflation Expectations: A New Model and New Facts

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See all articles by Lutz Kilian

Lutz Kilian

Federal Reserve Banks - Federal Reserve Bank of Dallas; Centre for Economic Policy Research (CEPR)

Xiaoqing Zhou

Federal Reserve Banks - Federal Reserve Bank of Dallas

Date Written: November 15, 2020

Abstract

The conventional wisdom that inflation expectations respond to the level of the price of
oil (or the price of gasoline) is based on testing the null hypothesis of a zero slope coefficient in a
static single-equation regression model fit to aggregate data. Given that the regressor in this
model is not stationary, the null distribution of the t-test statistic is nonstandard, invalidating the
use of the normal approximation. Once the critical values are adjusted, these regressions provide
no support for the conventional wisdom. Using a new structural vector regression model,
however, we demonstrate that gasoline price shocks may indeed drive one-year household
inflation expectations. The model shows that there have been several such episodes since 1990.
In particular, the rise in household inflation expectations between 2009 and 2013 is almost
entirely explained by a large increase in gasoline prices. However, on average, gasoline price
shocks account for only 39% of the variation in household inflation expectations since 1981.

Keywords: Inflation, expectations, anchor, missing disinflation, oil price, gasoline price, household survey

JEL Classification: E31, E52, Q43

Suggested Citation

Kilian, Lutz and Zhou, Xiaoqing, Oil Prices, Gasoline Prices and Inflation Expectations: A New Model and New Facts (November 15, 2020). CFS Working Paper, No. 645, 2020, Available at SSRN: https://ssrn.com/abstract=

Lutz Kilian (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Dallas ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Xiaoqing Zhou

Federal Reserve Banks - Federal Reserve Bank of Dallas ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States

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