This is a guest post from Steve from Virginia.

Last week, Dave Murphy (EROI Guy) explored how increasing energy prices during the run up to 2008's $147 bbl peak affected purchasing power of consumers and subsequently the solvency of the establishment that relied on that purchasing power. He mentions James Hamilton:

Hamilton acknowledges early on in his report that the proportion of income spent on energy is an important determinant of consumer spending patterns. The theory is fairly simple: if energy expenditures rise faster than income, then the share of income for other things besides purchasing energy must decline, such as spending on mortgage payments for a second home in Las Vegas. In other words, rapid, large increases in energy prices may curtail consumption enough to trigger larger financial problems – like the bursting of a housing bubble – that when aggregated across an economy may cause or contribute significantly to a recession.

I will show an even greater connection between energy prices, interest rates, and the financial sector, based in large part on a review of minutes of the Federal Reserve Open Market Committee (FOMC) from the end of 2002 to 2007. It appears the Fed’s inflation expectations were very closely linked to petroleum prices. Because of this, the rise in oil prices led the Fed to raise interest rates in an attempt to control inflation, which in turn had unintended consequences.