Commodity Prices, Monetary Policy, and Currency Regimes

Abstract

Commodity prices are back. This paper looks at connections between monetary policy, and agricultural and mineral commodities. We begin with the monetary influences on commodity prices, first for a large country such as the United States, then smaller countries. The claim is that low real interest rates lead to high real commodity prices. The theory is an analogy with Dornbusch overshooting. The relationship between real interest rates and real commodity prices is also supported empirically. One channel through which this effect is accomplished is a negative effect of interest rates on the desire to carry commodity inventories. The paper concludes with a consideration of the reverse causality: the possible influence of commodity prices on monetary policy, under alternative currency regimes. The new proposal for PEPI - Peg the Export Price Index - is compared (favorably) with - the popular regime of CPI targeting - by the criterion of robustness with respect to changes in the terms of trade such as oil price shocks.