Oil Price and Inflation: What’s the Correlation?

A historical parallel with a modern rebuttal

In the 1970s and early 1980s, the world witnessed back-to-back oil crises triggered by the OPEC embargo in 1973 and the Iranian Revolution in 1979. Oil prices soared, and inflation in the US and other OECD economies followed suit. The Consumer Price Index (CPI) more than doubled by the end of 1980, giving rise to the term “stagflation” — low growth, high unemployment, and high inflation.

But the underlying causes of that inflation are now contested.

An analysis by Lutz Kilian, Vice President at the Federal Reserve Bank of Dallas challenges the traditional view.

“Worldwide shifts in monetary policy regimes in the early 1970s played a major role in causing both oil price increases and the high inflation in many OECD economies,” Killian highlighted in a 2024 presentation.

Under this view, it was expansionary monetary policy — not oil prices alone — that lit the inflationary fire.

Structural models have shown that oil demand shocks, rather than supply shocks or geopolitically driven shortages, were the primary cause of price surges. The oil price, in many respects, followed inflationary pressures rather than led them.

Spiking oil prices caused the CPI to more than double by the end of 1980. In comparison, notes Investopedia, “it had previously taken 24 years (1947-1971) for the CPI to double. The result was a period of stagflation — low economic growth, high unemployment and high inflation.”

The relationship between oil prices and the CPI has eroded in the years since then. When the fuel climbed from US$14 to US$30 per barrel within six months in 1991 during the first Gulf War, the CPI barely budged.

Additionally, the monumental oil price rally that drove crude prices up from just US$16 to US$50 between 1999 and 2005 had a marginal impact on the CPI. More importantly, these more recent oil prices spikes had little impact on economic growth, unemployment rates or inflation levels.

What's behind this decoupling?

Some have suggested improvements in energy efficiency have lowered energy consumption per dollar across many industries. Others have argued that since the 1990s, monetary policymakers have changed the methods by which they control inflation, in effect softening the impact of higher oil prices.

Economists, including those at the St. Louis Federal Reserve, have pointed to the fact that the US CPI basket has increasingly become more heavily weighted with services rather than goods tied to oil.

Interest rates, oil, and a new dynamic

In the past, the Federal Reserve often responded to rising inflation (and by extension, oil prices) by raising interest rates. But does this monetary tightening then pull oil prices down?

Not necessarily. In fact, Iaccino points out that in the last six rate hike cycles, oil prices actually rose by an average of 16.06 percent in the six months following the hikes.

“There are many other factors affecting the price of crude oil, including geopolitics and sudden increases in supply or demand,” he noted. “Typically, rising crude oil prices are either a significant component in the cause of broader inflation, or the rise in oil price is a function of a strong economy and greater demand.”

This complexity was on full display in 2023. After the Fed raised interest rates in May, oil prices briefly dipped but rebounded quickly, climbing from US$65.48 in early May to US$83.60 by late July — even after another rate hike. It was clear that supply-side dynamics, such as OPEC+ production decisions and falling US inventories, had a stronger short-term influence than monetary policy.

The 2025 oil market tug-of-war

The first quarter of 2025 has reinforced the idea that oil prices are shaped more by geopolitics and market fundamentals than by central banks.

Starting the year above US$70, oil prices climbed briefly before tumbling as OPEC+ reversed course and announced a 411,000 barrel-per-day production increase. Analysts saw this move as a punitive measure against over-producing members like Iraq and Kazakhstan, despite the group officially claiming it was to “support market stability.”

Ole Hansen, head of commodity strategy at Saxo Bank, told the Investing News Network, “We're into supply destruction territory for some of the high-cost producers.” He added that if prices remain in the high US$50s, US output will likely slow — a dynamic that may help realign supply and demand later in the year.

The US Energy Information Administration (EIA) now expects Brent crude to average less than US$70 per barrel in 2025, citing growing inventories and subdued demand. Their April report forecasts a further drop to just over US$60 per barrel in 2026.

Oil prices still matter, but are no longer driving inflation

While oil is an important factor in inflation dynamics, it is no longer the inflationary hammer it once was.

As Kilian emphasizes, “Rising oil prices were a symptom rather than the cause of high US inflation” in the 1970s. That lesson appears to hold true today, as monetary policy, labor costs, and supply chain dynamics play increasingly dominant roles in shaping price pressures.

Moreover, the disconnect between headline oil prices and refined product costs — such as gasoline or diesel — complicates matters. Factors like refining costs, taxes, and distribution markups can dilute the direct pass-through of crude oil changes to the consumer level.

Natural gas markets illustrate a parallel complexity. While colder-than-average winter conditions in early 2025 pushed US natural gas prices up 13.9 percent in Q1, the overall inflationary impact has remained marginal — contained largely within energy-related sectors.

The once-clear link between oil and inflation has become fogged by decades of structural economic shifts, policy changes, and new global dynamics. Oil prices remain an important — but no longer dominant — signal of inflation.

In 2025, watching oil is still useful, but interpreting its message requires caution. A broader macroeconomic view does not demonstrate a single cause-and-effect story anymore, but rather a crucial variable in a vastly interconnected market propelled by real-world events.

In other words, the next time oil prices spike — or plunge — investors, policymakers, and consumers alike would be wise to ask a more complicated question: Why?