It’s a mundane day for errands: you run out to the store to pick up some groceries, some drugstore supplies, and fill up the gas tank. Afterward, you cook up some lunch on the gas stove.
For all this, you’d be spending roughly 8.5 percent more than you were a year ago, based on the Bureau of Labor Statistics’ July report on prices for consumer goods and services — over the course of the month, that translates into roughly $500 more for most households than last year.
Economists have pointed to energy prices as the main reason for high inflation. Americans have had to spend more on gasoline, on natural gas for stoves, water heaters, and furnaces, and on any electricity derived from oil and gas. But the impact from fossil fuels is bigger than that — energy prices indirectly affect virtually every part of the economy.
The impact of higher energy prices is especially evident in food prices, because most of the cost of food is based on how expensive it is to get from the farm to the shelf. But it’s also affecting other consumer goods. For example, Amazon recently hiked its Amazon Prime rates in European countries, citing rising costs for fuel and transportation.
Mark Zandi, Moody’s chief economist, said fossil fuels were a major cause of every period of inflation since World War II. “Invariably, it’s the high cost of oil and fossil fuels in general that drive big fluctuations and overall inflation,” Zandi said. “Every recession since World War II has been preceded by a jump in oil prices.”
Higher oil and gas prices are responsible for about 40 percent of the price increases across the economy (or 3.8 percentage points of the 8.5 percent inflation from July, according to calculations from Moody’s).
One big reason that inflation cooled down this month could be that energy prices are falling; natural gas and gasoline are cheaper than they were earlier in the year. But even though prices have decreased, they are still higher than a year ago. In general, the consumer can still expect to be paying a lot more for goods and services in the near future.
The interplay between the price of fuel and the price of everything else over the last year shows what a tight hold fossil fuels have on the economy. The US is trapped in a cycle where oil and gas prices go up, and political leaders try to do everything they can to bring them down again to lessen the burden on inflation. It pits renewable energy sources against the economy. Breaking free of this means shifting to more electricity that’s powered by solar and wind to fuel cars, homes, and businesses.
Reducing reliance on fossil fuels “will significantly reduce its grip on inflation in the broader economy,” said Zandi.
It’s the reason why economists eventually expect the Inflation Reduction Act to live up to the bill’s name.
Fossilflation, explained
A complicated set of factors is driving inflation right now — including but not limited to supply chain problems, insufficient labor, and anticipated gas shortages in Europe — but dig a bit deeper, and a common element is reliance on fossil fuels.
Inflation isn’t just an issue in the US or because of federal spending in the pandemic. It’s doubled in the last year in 37 advanced economies.
In some circles, economists have preferred to use “fossilflation” as the more accurate description of current inflation woes. European Central Bank executive board member Isabel Schnabel used the term in a March speech on the new age of inflation. “Fossilflation reflects the legacy cost of the dependency on fossil energy sources,” she said.
Volatility is always a feature of relying heavily on fuels to drive the economy. These are commodities that have to be stored, refined, and transported; as Gernot Wagner, a climate economist at Columbia Business School, explained, “commodities always fluctuate.”
This was especially true in the 1970s and ’80s when the economy suffered under even higher inflation. The circumstances driving higher prices today are different, of course. The oil industry has had a tumultuous few years during the pandemic: it is now drilling fewer wells and struggling with limited available refinery capacity that hasn’t matched the sharp rise in demand. And Russia’s invasion of Ukraine and the resulting global sanctions have lowered available supplies of oil and gas, and prices are higher accordingly in anticipation of winter shortages in Europe.
“A hundred years into the oil age it shouldn’t surprise us anymore that every decade or so something happens somewhere and prices go up,” Wagner said.
BLS’s July report actually showed no growth in inflation last month. The reason is the same: fossil fuel prices. Zandi explained that June’s high numbers reflected Europe’s decision to sanction Russian oil and gas. But investors seemed to have overestimated the impact on actual global oil and gas supplies, which is why prices came down a bit in the following weeks.
It’s not ideal to be this tethered to oil’s ups and downs. The oil industry is reaping rewards while consumers suffer higher prices. The 50 biggest oil and gas companies raked in $113 billion in profit so far in 2022, because of high prices, according to one calculation. And they’re still getting billions in subsidies, with the entire US oil and gas industry receiving more than $20 billion in tax breaks, according to a 2017 analysis from Oil Change International.
The solutions for climate change perform double duty and help consumers break free from this cycle. Green tech isn’t a panacea for the economy; in fact, “greenflation” is the term coined for higher demand for copper, lithium, and cobalt needed for clean technology. But moving off of fossil fuels does help in one major way. Rather than rely on fuel, a commodity, Wagner argues that the US adopting renewables will mean a switch to technological solutions. “Technologies, by definition, get better and get cheaper,” he said. “That’s the way to get off the unfortunate cycle of fossilflation.”
Breaking the cycle of “fossilflation”
What Congress’s investments could do, if they truly help to move the American economy off of its fossil fuel reliance, is to break the economy free from the volatility of oil markets.
The Inflation Reduction Act promises to help because it does a few simultaneous things. It invests in solutions that help to reduce consumer demand for fossil fuels, and incentivizes manufacturers and businesses to do the same. It also raises taxes on corporations, another way of curbing inflation, “not dissimilar to the Fed raising [interest] rates,” said Energy Innovation’s Robbie Orvis, an economic modeler who has studied the impact of the bill.
The IRA’s nearly $370 billion in climate measures aren’t going to make a dent in current inflation. But as the decade goes on, economists like Zandi expect that Americans may start to feel some difference.
Moody’s estimates that by 2030, the bill could reduce the typical American household’s spending on energy by more than $300 each year, in today’s dollars. It also may help with insurance rates for home and business properties because of its investments slashing emissions (which worsen climate change) and in physical climate adaptation.
Another report from Rewiring America finds even greater gains when tallying up the bill’s total tax credits for electric vehicles, rooftop solar, and electric appliances like heat pumps. Rewiring America found a household would save $1,800 annually if it adopted all this clean tech. Of course, doing all this in your household costs a lot of money up front. There are still some policies in the bill that target low-income households specifically, like expanding a low-income home rebate that covers the full cost of heat pump installation, with a cap of $8,000.
“That could go a long way to mitigating the ups and downs in the broader economy and our standard of living,” Zandi said.
These policies are too late to help with high prices in the immediate future, but they will stem the impact of the next major crisis.
