How to Cope with Volatile Commodity Export Prices: Four Proposals

Abstract

Countries that specialize in commodities have in recent years been hit by high volatility in world prices for their exports.

This paper suggests four ways that commodity-exporters can make themselves less vulnerable:

(1) They can use option contracts to hedge against short-term declines in the commodity price without giving up the upside, as Mexico has shown.

(2) Commodity-linked bonds can hedge longer-term risk, and often have a natural ultimate counter-party in multinational corporations that depend on the commodity as an input.

(3) The well-documented pro-cyclicality of fiscal policy among commodity exporters can be reduced by insulating official forecasters against optimism bias, as Chile has shown.

(4) Monetary policy can be made automatically more counter-cyclical, judged by the criterion of currency appreciation in reaction to positive terms-of-trade shocks, under either of two regimes: Peggers can add the export commodity to a currency basket (CCB, for “Currency-plus-Commodity Basket”) and others can target Nominal Income instead of the CPI.

Keywords: agriculture, commodities, currency basket, fiscal, hedging, indexed bonds, minerals, monetary, oil

JEL Classification: E, F, G, O