June 23 (Bloomberg) -- High oil prices present a rebuke to U.S. President Harry Truman's famous request for a one-handed economist who would never offer ``on the one hand, on the other hand'' solutions.

Oil shocks are, in a word, stagflationary: On the one hand, they can increase prices throughout the economy, hastening inflation and justifying tighter monetary policy; on the other hand, they can clamp down on consumer spending, damp growth and provide a rationale for monetary easing.

Indeed, the recent oil price increase may be provoking an ``on the one continent, on the other continent'' split between a more growth-focused U.S. Federal Reserve and a more inflation- averse European Central Bank.

Earlier this month, Fed Chairman Alan Greenspan raised eyebrows about oil prices driving inflation concerns when he said ``the persistence of the rise in energy prices is a worrisome element in the cost picture.''

Away From Accommodation

But last week, Fed watchers seemed to return to the sounder position that higher energy prices would make Greenspan more cautious about raising rates, not less so. The reason? A 0.6 percent increase in consumer prices in May that hardly spilled over into core inflation -- which grew at a modest 0.2 percent -- and Greenspan's reassuring words that movement away from accommodation was ``very likely to be measured.''

One hardly needed last week's news to conclude that energy costs were unlikely to push the Fed to raise rates faster than the projected 25 basis points per meeting. First, while some analysts point out that investments in conservation and a growing knowledge sector have made our economy less energy-dependent -- energy consumption per dollar of real gross domestic product has fallen 46 percent since 1973 -- that only tells part of the story.

Oil-Dependant

Over the same period, we have also become far more dependent on foreign sources of oil, which means profits from price increases are siphoned off by foreign producers, not recycled back into the American economy. Goldman Sachs Group Inc. estimates that net oil imports have actually risen as a percentage of GDP from 0.9 percent in 1970 to 1.2 percent in 2003, suggesting the impact of oil prices on U.S. real income is, if anything, slightly higher than in 1970.

Merrill Lynch & Co. recently projected that sustained $40-a- barrel oil could lower 2004 GDP growth by about 0.5 percentage point.

Furthermore, increases in energy prices may have an even greater impact on demand than economists expect because of ``in your face'' -- or more aptly, ``out of your pocket'' -- effects that higher prices at the pump or in home heating bills can have on typical working families.

During the summer of 2000, I remember watching an interview with a woman filling up her sport-utility vehicle who explained that with gas prices up as much as 50 cents a gallon, she was reconsidering the family's annual trip to visit her mother, who lived 150 miles away. While I was calculating that the trip would probably only cost her an extra $10, I could see her kids coming back to the car with Slurpees and potato chips.

``C'mon,'' I remember thinking, ``skip the junk food and go see Grandma.''

Complex Response

In April 2002 testimony, Greenspan more than hinted that economic models might not fully capture the impact energy-price increases can have on consumer demand. ``The responsiveness of U.S. GDP to energy prices,'' he explained, ``is far more complex and may be quite different when households and businesses are confronted with abnormal price hikes. Macro econometric models typically may not capture the effect of sudden and sizable shifts in oil prices on the economy.''

Finally, even though we are coming off three years of exceptional monetary accommodation, lingering weakness in the labor market has not been reversed with three solid months of job growth. Real weekly wages have actually fallen since December 2001, and labor-force participation is the lowest since 1988.

As Fed Governor Donald Kohn said earlier this month, ``the economy continues to operate with an appreciable -- albeit diminishing -- margin of slack.''

Digesting Deficits

And with the recovery so dependent on interest-sensitive sectors of the economy -- housing and autos -- the Fed has reason to worry how purchases of these big-ticket items will be affected as the market fully digests the long-term problem of large budget deficits, even if sustainable growth returns.

It is on the other side of the Atlantic that energy prices may be leading central bankers to fear inflation more than slowed growth. While the European economy has seen a modest recovery recently, 9 percent unemployment and 1.3 percent annual GDP growth in the first quarter would suggest that the ECB might be better off focusing on boosting the economy.

Yet in April, the ECB shrugged off calls for lower rates, and since then, rising oil prices have pushed up the inflation rate to an annual 2.5 percent, the highest in two years. With an inflation target of ``close to, but below'' 2 percent, the ECB is unlikely to contemplate rate cuts and may even consider raising rates, giving Greenspan and Co. yet another reason to be wary of aggressive tightening.

ECB President Jean-Claude Trichet recently affirmed that ``whatever happens, our main responsibility is to prevent second- round effects which would make higher inflation a permanent feature and which would prevent us from delivering price stability.''

The moral of the story is that oil prices always require central bankers to have two hands -- to weigh the ``stag'' versus the ``flation.'' The divergent responses to oil on both sides of the Atlantic could tell a lot about global monetary policy in the months ahead.

To contact the writer of this column: Gene Sperling at at gsperling@cfr.org.

Last Updated: June 23, 2004 00:09 EDT