By overlooking the very changed economic context in which the present run-up in international oil prices is occurring, your editorial "Spooking the market" (July 15) was too sanguine about the potential adverse impact of further oil price increases on the US economy.

Resident Fellow Desmond Lachman

Over the past two years, the US economy was characterised by a highly accommodative monetary policy and by ample excess capacity. As such, low interest rates masked the adverse effect of oil price increases on US economic activity. At the same time, excess capacity shielded the US economy from the inflationary impact of oil price increases.

With US interest rates now at more normal levels and with the US economy now operating at very close to capacity, one should expect international oil price increases to affect the economy in the more traditional manner of earlier oil price spikes.

For that reason, one would not want to underestimate the potential for further oil price increases to produce stagflation that could pose a real challenge for the Federal Reserve.

Desmond Lachman is a resident fellow at AEI.