WASHINTGTON, DC – Until a few weeks ago, while oil prices were surging, debate raged about the relative roles of economic fundamentals and speculation in boosting oil prices. Although oil prices have now fallen back from their peak, that debate must not be forgotten, for it has profound policy implications that government officials would be derelict to ignore.
Of course, if higher prices are due to fundamentals, oil markets are working as they should. But if they are due to speculation, then policymakers speculators must act to rein in behavior that has imposed huge and needless costs on the global economy. And, when the evidence is confronted, it points to speculation as a culprit.
Whereas many oil market participants have blamed speculation, most economists defend how oil markets have performed and point to economic fundamentals. One argument that economists use is that higher prices are due to the weak dollar. Because oil is priced in dollars, a weak dollar makes oil cheaper to users in other countries, which increases global demand.
A second argument is that higher oil prices are due to lower interest rates and anticipations of higher long-term prices. That supposedly reduced supply by encouraging producers to store oil in the ground and pump it later.