While moderately high oil prices are inflationary, extreme prices ($500/bbl) become massively deflationary by destroying demand across the entire economy. This paradox complicates the central bank response, as an initial inflationary shock could morph into a severe recessionary impulse.

David Rosenberg argues that for a price shock, like in energy, to create lasting inflation, it must lead to a wage-price spiral. Without wage growth to support higher prices, demand destruction occurs in discretionary sectors, containing the overall inflationary impulse. This is the critical missing link today.

Despite oil prices doubling, the economy didn't slow down because energy now constitutes a historically low share of consumer budgets. Instead of cutting back, confident consumers simply drew down their savings to cover the higher cost, turning the energy shock into a pure inflationary impulse rather than a demand-destroying event.

While initial energy price spikes boost short-term inflation expectations, a sustained shock eventually hurts economic growth. This growth concern acts as a natural ceiling on long-term inflation expectations (break-evens), as markets anticipate an economic slowdown, preventing them from rising indefinitely.

Current oil prices are stuck in a dangerous middle ground. They fuel inflation across the economy but aren't high enough to trigger the demand destruction that would force central banks into decisive action, creating a prolonged inflationary environment.

Unlike the 1970s oil crisis, today's energy shocks cause demand destruction because consumers are weaker. In the 70s, people had decades of real wage growth. Today, after decades of wage stagnation, consumers have no financial cushion, forcing them to cut spending immediately when prices rise.

Despite a still-growing labor market, real wage growth has slowed to "stall speed." This lagged effect on middle and lower-income households is the primary driver for the projected 2-percentage-point drop in real consumption growth for Q4 and Q1.

While not technically inflation, rising energy costs are perceived as such by working-class citizens because they make everything more expensive. This direct hit to their finances is a powerful driver of political dissatisfaction, regardless of other economic indicators.

Investors often rush to price in the disinflationary outcome of an oil shock (demand destruction). However, the causal chain is fixed: prices rise first, hitting real spending. Only much later does this weaken the labor market enough to reduce overall inflation, a process that can take 9-12 months to play out.