Monetary Policy Spillovers, Global Commodity Prices and Cooperation

61 Pages Posted: 31 Jan 2018

See all articles by Andrew J. Filardo

Andrew J. Filardo

Bank for International Settlements (BIS) - Monetary and Economic Department

Marco J. Lombardi

Bank for International Settlements (BIS) - Monetary and Economic Department

Carlos Montoro

Central Reserve Bank of Peru

Massimo Ferrari

Università Cattolica del Sacro Cuore (UCSC)

Date Written: January 2018

Abstract

How do monetary policy spillovers complicate the trade-offs faced by central banks face when responding to commodity prices? This question takes on particular relevance when monetary authorities find it difficult to accurately diagnose the drivers of commodity prices. If monetary authorities misdiagnose commodity price swings as being driven primarily by external supply shocks when they are in fact driven by global demand shocks, this conventional wisdom - to look through the first-round effects of commodity price fluctuations - may no longer be sound policy advice.

To analyse this question, we use the multi-country DSGE model of Nakov and Pescatori (2010) which breaks the global economy down into commodity-exporting and non-commodity-exporting economies. In an otherwise conventional DSGE setup, commodity prices are modelled as endogenously changing with global supply and demand developments, including global monetary policy conditions. This framework allows us to explore the implications of domestic monetary policy decisions when there is a risk of misdiagnosing the drivers of commodity prices.

The main findings are: i) monetary authorities deliver better economic performance when they are able to accurately identify the source of the shocks, ie global supply and demand shocks driving commodity prices; ii) when they find it difficult to identify the supply and demand shocks, monetary authorities can limit the deterioration in economic performance by targeting core inflation; and iii) the conventional wisdom approach of responding to global commodity price swings (as external supply shocks when they are truly global demand shocks) results in an excessive procyclicality of global inflation, output and commodity prices. In light of recent empirical studies documenting a significant role of global demand in driving commodity prices, we conclude that the systematic misdiagnoses inherent in the conventional wisdom applied at the country level have contributed to destabilising procyclicality at the global level. These findings support calls for greater attention to global factors in domestic monetary policymaking and highlight potential gains from greater monetary policy cooperation focused on accurate diagnoses of domestic and global sources of shocks.

Keywords: commodity prices, monetary policy, spillovers, global economy

JEL Classification: E52, E61

Suggested Citation

Filardo, Andrew J. and Lombardi, Marco Jacopo and Montoro, Carlos and Ferrari, Massimo, Monetary Policy Spillovers, Global Commodity Prices and Cooperation (January 2018). BIS Working Paper No. 696. Available at SSRN: https://ssrn.com/abstract=3113514

Andrew J. Filardo (Contact Author)

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

Marco Jacopo Lombardi

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland
+41612809492 (Phone)

Carlos Montoro

Central Reserve Bank of Peru ( email )

Jirón Miroquesada 441
Lima, Lima 1
Peru

Massimo Ferrari

Università Cattolica del Sacro Cuore (UCSC) ( email )

1 Largo A. Gemelli
Milano (Milan), MI Milano 20123
Italy

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