Sir, Joachim Fels does us a service by reminding us of the many parallels between the current oil price shock and that of the 1970s. However, by failing to highlight the very different context within which the present oil price shock is occurring compared with that of the 1970s, he erroneously arrives at the conclusion that inflation will almost certainly pick up as monetary policy stays on an expansionary path for too long.

A compelling reason for the Federal Reserve to be cautious in not responding to the present oil price shock by raising interest rates is the weak general macroeconomic environment within which that shock is occurring. Even prior to the present oil price shock, second-quarter U.S. gross domestic product data indicated that the U.S. economy had slowed to a rate of growth somewhat below its long-term growth potential. Since then, the economy has been experiencing a "soft patch", while core price inflation has resumed its deceleration to about 1.5 percent, well within the Fed's comfort zone.

In spite of the considerable progress made over the past 30 years in reducing the industrialised economies' energy dependence, the International Monetary Fund estimates that a sustained $5 a barrel oil price increase reduces global GDP growth by 0.3 percentage points and U.S. GDP growth by 0.4 percentage points. On that basis, one would expect that were oil prices to stay at about $50 a barrel, U.S. GDP growth in 2005 would be around 1¼ percentage points lower than it would otherwise have been.

In the period ahead, not only will the U.S. economy have to withstand higher oil prices, it will also have to cope with the fading of the significant tax refunds of the first half of 2004. In those circumstances, and with core inflation well contained, prudence would suggest that the Fed should not be too hasty in returning interest rates to more neutral levels. This would appear to be a very much less risky course than reacting in a knee-jerk fashion to higher oil prices by raising interest rates, which could further slow an already weakening and non-inflationary economy.

Desmond Lachman is a resident fellow at the American Enterprise Institute.