Commodity Prices, Overshooting, Money Surprises, and Fed Credibility

27 Pages Posted: 6 Apr 2004 Last revised: 27 Jul 2022

See all articles by Jeffrey A. Frankel

Jeffrey A. Frankel

Harvard University - Harvard Kennedy School (HKS); National Bureau of Economic Research (NBER)

Gikas A. Hardouvelis

University of Piraeus; Centre for Economic Policy Research (CEPR)

Date Written: May 1983

Abstract

The general price level does not provide a sensitive indicator of whether monetary policy is tight or loose, because mostprices are sticky. Interest rates are free to move, but they are an ambiguous indicator of monetary policy: one does not know whether changes in the interest rate are due to changes in the expected inflation rate or the real interest rate.Commodity prices provide the ideal sensitive indicator.This paper has two distinct aims. First, a theoretical model of "over-shooting" in commodity markets is presented. A known change in the money supply is shown to cause an instantaneous change in commodity prices that is greater than the proportionate change that describes long-run equilibrium.Second, we take the occasion of the Fed's Friday money supply announcements to test the theory. We find that an unexpectedly large money announcement causes significant negative reactions in prices of six commodities. This supports at once the sticky-price or overshooting view, and the notion that the market has confidence in the Fed's commitment to correct any deviations from its money growth targets.

Suggested Citation

Frankel, Jeffrey A. and Hardouvelis, Gikas A., Commodity Prices, Overshooting, Money Surprises, and Fed Credibility (May 1983). NBER Working Paper No. w1121, Available at SSRN: https://ssrn.com/abstract=304839

Jeffrey A. Frankel (Contact Author)

Harvard University - Harvard Kennedy School (HKS) ( email )

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National Bureau of Economic Research (NBER)

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Gikas A. Hardouvelis

University of Piraeus ( email )

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HOME PAGE: http://www.eurobank.gr

Centre for Economic Policy Research (CEPR) ( email )

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United Kingdom

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