ECONOMIC CoMMENTARY - Do Oil Prices Predict Inflation?

Sep 21, 2026

Uploaded by Finn

Economic Commentary examines whether oil prices can predict future inflation measured by the CPI and the core CPI. Using multiple statistical tests and several forecasting models—some including oil prices, economic slack, underlying inflation, and survey expectations—the study evaluates forecast performance via root mean squared error (RMSE) across time periods. Results indicate oil prices add little or no predictive value for CPI inflation forecasts and perform even worse for core CPI, explaining mainly short-term CPI movements rather than next-year inflation trends.

LanguageEnglish

CategoryResearch & Report

FormatPDF

Pages5

Reading Time13 min

AccessFree to download

Do Oil Prices Predict Inflation?

Forecasting Core CPI

# ECONOMIC CoMMENTARY Do Oil Prices Predict Inflation? Mehmet Pasaogullari and Patricia Waiwood Some analysts pay particular attention to oil prices,thinking they might give an advance signal of changes in inflation.However,using a variety of statistical tests,we find that adding oil prices doeslitle to improve forecasts of CPl inflation.Our results suggest that higher oil prices today do not necessarily signal higher CPI inflation next year,although they dohelp to explain short-term movements in the CPI. Pcople pay a lot of attention to inflation and expend a greatdeal of effort trying to predict what prices will do in thefuture.Some pay particular attention to oil prices,thinkingthat they might give an advance signal of changes ininflation.After all,gasoline prices do constitute a significantpart of the Consumer Price Index(CPI)-about 6 percentin 2012-so changes in oil prices would be expected toaffect inflation as measured by the CPI.Oil is also requiredto produce or deliver most goods and services,so risingoil prices may feed through to their prices as well.In fact,in the data there is a rather high degree of comovementbetween changes in gasoline prices and the CPI(figure 1). In this Economic Commentary,we put the possible relationshipbetween oil prices and inflation to the test.In particular;we compare the forecast value of oil to a number of othervariables such as economic slack,underlying (core)inflation,and survey measures of expected inflation,assessing oil'sability to improve the forecast of inflation as measured eitherby the CPI or the core CPI (which excludes energy andfood prices).We look at how well oil helps to predict annualinflation four quarters ahead-or doesn't.Using a variety ofstatistical tests,our analysis shows that adding oil prices doeslittle to improve forecasts of CPI inflation and does an evenworse job at improving forecasts of core CPI inflation. Number 201401 Forecasting CPI Inflation with and without Oil PricesOur study follows in the footsteps of a study done previouslyby economists at the Federal Reserve Bank of Cleveland,"Simple Ways to Forecast Inflation:What Works Best,"where several models were compared in terms of their abilityto forecast future inflation.Here,we extend that analysis byincluding oil as a forecasting variable in similar models. Figure 1.Monthly Changes for CPI,Core CPI,and Gasoline Prices Source:Bureau of Labor Statistics. We consider oil's ability to forecast both the CPI and thecore CPI.We look at both inflation measures for a coupleof reasons.First,since oil is included in the CPI but not inthe core CPI,comparing the power of oil to predict eachmeasure could be informative.Second,core measures ofinflation have become increasingly important to the FOMCover time,especially for filtering out the near-term effects oftransitory movements,so it's worth exploring anything thatmight improve forecasts of those measures. We constructed a variety of forecasts using a number ofvariables.Some variations use only past inflation to forecastfuture inflation,some include the inflation forecasts ofprofessionals or consumers,some include oil prices,andsome include various combinations of these.One variantsimply assumes that next year's inflation will be the same asthis year's (the so-called naive forecast).Each variation ofthe model was run once to produce a forecast for the CPIand once for the core CPI. To compare the accuracy of our various models,wecomputed the root mean squared error (RMSE)statistic forcach forecast.As a measure of forecast error,an RMSE ofzero indicates a perfect performance.The lower the RMSEis,the smaller the average squared deviation between theforecasted values and the realized ones.In short,smallerRMSEs reflect better predictions on average. Figure 2 shows the RMSE of the best forecasts of CPIinflation with and without oil prices.Our results suggest thatoil prices have little or no predictive value for forecastingCPI inflation,regardless

FAQs

Oil prices can help predict inflation—what does the study conclude?

Adding oil prices provides little to no improvement in forecasting CPI inflation, and it performs even worse for forecasting core CPI inflation.

How does the study measure forecast accuracy?

It compares models using root mean squared error (RMSE), where a lower RMSE indicates better predictive performance.

Why are CPI and core CPI analyzed differently?

Oil is part of the CPI but excluded from the core CPI, and core measures are also important for filtering transitory effects from short-term movements.

Sep 21, 2026

Uploaded by Finn