What Is the Relationship Between Oil Prices and Inflation?

Oil prices and inflation have a cause and effect relationship

Fact checked by Vikki Velasquez
Reviewed by Gordon Scott

Crude oil is a major economic input so a rise in oil prices contributes to inflation which measures the overall rate of price increases across the economy.

Inflation as measured by the annual gain in the U.S. Consumer Price Index (CPI) set a 40-year high in March 2022 amid COVID-19 supply disruptions. Crude oil prices were the highest in a decade as the U.S. and its allies imposed sanctions on Russia due to its invasion of Ukraine.

Key Takeaways

• Higher oil prices contribute to inflation directly and by increasing the cost of inputs.
• There was a strong correlation between inflation and oil prices during the 1970s.
• Oil’s potential to stoke inflation has declined as the U.S. economy has become less dependent on it.
• Oil prices exert a greater influence on producer prices because of oil’s role as a key input.
• Some argue that costly renewable energy could re-strengthen the correlation between energy costs and a higher inflation rate.

Cause and Effect

Higher oil prices raise inflation indirectly because crude oil is a key ingredient in petrochemicals used to make plastic. More expensive oil will therefore tend to increase the prices of many products made with plastic.

Consumer prices also factor in transportation costs, including fuel prices. The cost of oil accounts for roughly half the retail price of gasoline.

The indirect contributions of crude oil prices to inflation are reflected in the core CPI index which doesn’t include energy or food prices because they tend to be more volatile.

Important

The energy index of the CPI fell by 2.4% in March 2025 then rebounded and increased 0.7% in April.

Federal Reserve Chair Jerome Powell said in his semiannual testimony before the U.S. Senate Banking Committee in March 2022 that every $10 per barrel increase in the price of crude oil raises inflation by 0.2% and sets back economic growth 0.1%.

A study by the Federal Reserve Bank of Dallas in September 2021 suggested that the spike would boost the annual inflation rate by three percentage points in the short term if crude oil prices rose to $100 per barrel for three months before retreating with the effect fading quickly as oil prices pulled back.

Shifting Trends

Crude oil was a bigger contributor to inflation in the 1970s when it was used much more intensively per unit of economic output. The U.S. economy consumed more than a barrel of crude per $1,000 of gross domestic product back then. That had dropped to about 0.4 barrels per $1,000 of GDP by 2019.

Reduced reliance on energy and particularly on crude oil promoted disinflation or a decline in the inflation rate.

Spot oil prices have retained a strong correlation to market measures of long-term inflation expectations, however.

Some analysts have argued that the correlation between crude’s diminished importance as an economic input and a lower inflation rate may no longer hold as oil is supplemented by less climate-damaging but more expensive renewable energy sources. Global supply chains are giving way to costlier domestic or regional sourcing.

Goods Producers Pay the Price

Oil prices have historically exerted more influence on the Producer Price Index (PPI) than the CPI. The PPI measures the prices of goods at the wholesale level. The CPI measures the prices that consumers pay for goods and services.

The correlation between oil prices and the PPI was 0.71 between 1970 and 2017. That’s much stronger than the 0.27 correlation with the CPI, according to the Federal Reserve Bank of St. Louis.

“The weaker link between oil prices and consumer prices likely comes from the relatively higher weight of services in the U.S. consumption basket, which you’d expect to rely less on oil as a production input,” according to the St. Louis Fed.

The Federal Reserve’s preferred inflation measure is the personal consumption expenditures price index. It has a lower gasoline weighting than the CPI.

Is Inflation Good or Bad for Oil Prices?

It depends on the time frame. Higher inflation tends to lead to higher oil prices in the short term. Oil prices could decline in the longer term if the Federal Reserve raises interest rates and slows economic growth to control inflation.

What Type of Inflation Would Be Triggered by an Increase in Oil Prices?

Oil prices have historically had a greater impact on the Producer Price Index (PPI) than on CPI. PPI measures the price of goods at the wholesale level.

What Other Factors Can Cause Oil Prices to Rise?

Other factors that can cause oil prices to rise include geopolitical tensions, tight supply, and growing economic strength.

The Bottom Line

The price of oil has historically correlated with inflation but that relationship has become less pronounced since the 1970s. The loosening of this correlation is likely a result of the growth of the service sector which uses energy less intensively than manufacturing.

Oil is a key input in manufacturing and a major cost factor in shipping so oil prices have tended to have a greater effect on the cost of goods than services. This also explains the relatively weak correlation between oil and CPI and the strong one between crude and PPI.