1 Increases in Global Increases in Global Commodity Prices: Commodity Prices: The Macroeconomics The Macroeconomics and Policy Responses and Policy Responses of Developing Countries of Developing Countries Prof. Jeffrey Frankel, Prof. Jeffrey Frankel, Harvard Harvard University University V Jornada Monetaria, Banco Central de Bolivia V Jornada Monetaria, Banco Central de Bolivia Crisis Alimentaria, Inflación y Respuestos de Política Crisis Alimentaria, Inflación y Respuestos de Política 18 July, 2011, La Paz 18 July, 2011, La Paz
Transcript
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Increases in Global Increases in Global Commodity Prices:Commodity Prices: The MacroeconomicsThe Macroeconomicsand Policy Responses and Policy Responses of Developing Countriesof Developing Countries
Prof. Jeffrey Frankel,Prof. Jeffrey Frankel, Harvard UniversityHarvard University
V Jornada Monetaria, Banco Central de BoliviaV Jornada Monetaria, Banco Central de Bolivia
Crisis Alimentaria, Inflación y Respuestos de PolíticaCrisis Alimentaria, Inflación y Respuestos de Política
18 July, 2011, La Paz18 July, 2011, La Paz
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Prices of foodPrices of food && other other commodities are again raising commodities are again raising concerns.concerns.
French President N. Sarkozy French President N. Sarkozy placed food price volatility placed food price volatility on the G-20 agenda for 2011.on the G-20 agenda for 2011.
Many fingers of blame have been pointed:Many fingers of blame have been pointed: at global climate changeat global climate change At “evil speculators,” At “evil speculators,” at the US Fed, at the US Fed, at growth in China…at growth in China…
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The questionsThe questions
II. . Why are pricesWhy are prices of of foodfood & & otherother commodities socommodities so high?high?
II. What is theII. What is the record record with with microeconomicmicroeconomic policies topolicies to trytryto reduce the volatility to reduce the volatility of theof the prices of prices of imported imported commodities?commodities?
III. How should a food importer set monetary policy?III. How should a food importer set monetary policy?
IV. How does the answer change for a country IV. How does the answer change for a country that also exports commodities that also exports commodities (e.g., minerals),(e.g., minerals), with world prices that are equally volatile?with world prices that are equally volatile?
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20082008 & & 2011 commodity price 2011 commodity price spikes were as high as the spikes were as high as the 1970s1970s
*) Deflated by US consumer price index.Source: HWWA, Datastream.
Nominal prices2010=100
Real prices * = nominal in 2000
A.Saiki, Dutch Nat.Bk.
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I. Why are prices for food I. Why are prices for food & other commodities so high?& other commodities so high? Two competing views Two competing views
of how prices are determinedof how prices are determined ““Commodities are goods.”Commodities are goods.” => Prices are determined by => Prices are determined by the the flow of supplyflow of supply &&
demand demand andand their their current economic fundamentals, current economic fundamentals, such as disruptions from weather or politics.such as disruptions from weather or politics.
Vs. Vs.
““Commodities have become like assetsCommodities have become like assets,”,” especially those commodities that are storable.especially those commodities that are storable. => They are determined by calculations regarding expected => They are determined by calculations regarding expected
future fundamentals and alternative returns; future fundamentals and alternative returns; – – in other words, by speculators. in other words, by speculators.
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The asset model:The asset model:
If commoditiesIf commodities areare storablestorable & & marketsmarkets work efficientlywork efficiently the expected future change in the price the expected future change in the price
of the commodity of the commodity (relative to the interest rate), (relative to the interest rate),
should help determine today’s price.should help determine today’s price.
Via 3 channels:Via 3 channels: (i) the decision whether to harvest/(i) the decision whether to harvest/ cull/cull/ log/log/ extract todayextract today
vs leaving the crop/deposits in the fields/ground until tomorrow; vs leaving the crop/deposits in the fields/ground until tomorrow;
(ii) the decision whether to hold inventories, (ii) the decision whether to hold inventories, or to sell them today;or to sell them today;
(iii) the decision whether to go long in futures markets,(iii) the decision whether to go long in futures markets, or to go short.or to go short.
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In support of the flow/goods view:In support of the flow/goods view:
2008 observation: Paul Krugman argued that 2008 observation: Paul Krugman argued that inventories (stockpiles) of oil, etc., had not risen inventories (stockpiles) of oil, etc., had not risen as they should if the high prices were caused by an increase as they should if the high prices were caused by an increase
in the expected rate of return to holding commodities.in the expected rate of return to holding commodities.
2011 observation: 2011 observation: If flows did not matter, the release of oil from US SPR & If flows did not matter, the release of oil from US SPR & other countries’ stockpiles other countries’ stockpiles (30 m barrels each)(30 m barrels each) on June 23 on June 23 would not have caused prices to fall 4% that day.would not have caused prices to fall 4% that day.
Both views are partly right Both views are partly right (and partly wrong)(and partly wrong)
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In support of the asset view:In support of the asset view:
Although individual commodities Although individual commodities are impacted by “flow” fundamentals,are impacted by “flow” fundamentals,
such as Russian drought, US ethanol subsidies, such as Russian drought, US ethanol subsidies, instability in oil producing countries, etc., instability in oil producing countries, etc.,
it cannot be a coincidence that the prices it cannot be a coincidence that the prices of virtually all fuels, minerals, & farm products of virtually all fuels, minerals, & farm products rose sharply in 2008 and again in 2011.rose sharply in 2008 and again in 2011.
True, fuels & grains are partial substitutes in True, fuels & grains are partial substitutes in production; but this cannot be the full answer.production; but this cannot be the full answer.
Both views are partly right Both views are partly right (and partly wrong)(and partly wrong)
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As the asset view predicts, As the asset view predicts, real commodityreal commodity prices are prices are inversely related to the real inversely related to the real interest rateinterest rate
Real US interest rate
Real $foodpriceindex,
Moody’sexcl. oil
1951-2007 monthly
A.Saiki, Dutch Nat.Bk.
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Establishing that the asset model Establishing that the asset model is important does not imply that is important does not imply that speculators are destabilizing.speculators are destabilizing.
Speculation often reflects fundamentals.Speculation often reflects fundamentals. It can be It can be stabilizingstabilizing – –
dampening volatility when high prices dampening volatility when high prices are recognized as temporary;are recognized as temporary;
and carrying the message and carrying the message of likely future changes in fundamentals.of likely future changes in fundamentals.
But occasionally speculators But occasionally speculators areare destabilizing, destabilizing, carried away by speculative bubbles.carried away by speculative bubbles.
High commodity pricesHigh commodity prices (in $)(in $) over the last 5 years over the last 5 years can be attributed broadly can be attributed broadly to two factors:to two factors:
1.1. Low real interest ratesLow real interest rates
2.2. Strong growth Strong growth in China & other in China & other Emerging Markets Emerging Markets
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Macroeconomic determinants of real commodity prices
De trended G-4 GDP
US real interest rate
Constant R2/ /nobs
All commodities price index1992Q1-2010Q4
.033 (.004)
t = 7.6
-.047
(.010)
t = - 4.7
.962 (.037)
t = 26.3
.58/
/
/ 76
Real price of oil
1987Q1-
2010Q4
.039 (.006)
t = 7.0
-.072 (.011)
t = - 6.7
.879 (.046)
t = 19.2
.56/
/
/ 95Real price of wheat1990 Q1 – 2010 Q4
.025 (.006)
t = 4.0
-.028
(.013)
t = - 2.1
1.247
(.052)
t = 26.3
.23/
/
/ 83
A.Saiki, Dutch Nat.Bk.
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Regardless what Regardless what determines global determines global commodity prices, commodity prices, smallsmall && developing developing countries must take them countries must take them as given.as given.
Locally, in a small open economy,Locally, in a small open economy, price is exogenous in terms of $price is exogenous in terms of $ => => The exchange rate is mostly passed through The exchange rate is mostly passed through
to local-currency prices of the commodity.to local-currency prices of the commodity.
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The effects of high The effects of high agricultural pricesagricultural prices
Consumers are hurting worldwide,Consumers are hurting worldwide, especially the poor, especially the poor, for whom food takes a major bite for whom food takes a major bite
out of household budgets.out of household budgets.
Popular discontent over food prices has Popular discontent over food prices has fueled political instability in some countries,fueled political instability in some countries, most notably in Egypt & Tunisia,most notably in Egypt & Tunisia, contributing to the Arab Spring uprisings.contributing to the Arab Spring uprisings.
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MacroeconomicsMacroeconomics
If an increase in the price of food If an increase in the price of food is due to a boom in Aggregate Demand:is due to a boom in Aggregate Demand: then it can be offset by tighter monetary policy,then it can be offset by tighter monetary policy,
aided by currency appreciationaided by currency appreciation if the exchange rate is flexibleif the exchange rate is flexible..
GDP
PAS
AD'AD
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MacroeconomicsMacroeconomics
An increase in the price of food imports An increase in the price of food imports is an adverse Aggregate Supply shock:is an adverse Aggregate Supply shock: => higher inflation for any given level of GDP,=> higher inflation for any given level of GDP, or lower GDP for a given level of inflation.or lower GDP for a given level of inflation. Especially if inflation is measured by CPI.Especially if inflation is measured by CPI.
GDP
CPIAS
AS'
AD
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Monetary policy can’t offset Monetary policy can’t offset such a supply shocksuch a supply shock
If monetary policy is tightened to prevent the CPI If monetary policy is tightened to prevent the CPI from rising, from rising,
the result may be the result may be a severe recession.a severe recession.
The central bank The central bank cannot fight cannot fight a shift in a shift in the terms of trade.the terms of trade.
GDP
CPIAS
AS'
AD
AD'
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II. MicroeconomicsII. MicroeconomicsThe record with policies The record with policies to reduce the volatility to reduce the volatility of the prices of commoditiesof the prices of commodities
In theory, government stockpiles might In theory, government stockpiles might be able to smooth price fluctuations, be able to smooth price fluctuations, releasing stocks in times of shortage releasing stocks in times of shortage and buying when prices are low. and buying when prices are low.
But the record in practice But the record in practice is not encouraging.is not encouraging.
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The record with microeconomic policies to reduce The record with microeconomic policies to reduce the volatility of the prices of commodities, the volatility of the prices of commodities, continuedcontinued
In rich countries, the farm sector In rich countries, the farm sector is usually powerful politically;is usually powerful politically;
=> stockpiles of food products are used => stockpiles of food products are used to keep prices to keep prices highhigh rather than low. rather than low.
The EU’s Common Agricultural PolicyThe EU’s Common Agricultural Policyis a classic example – is a classic example – disastrous for EU budgets, disastrous for EU budgets,
economic efficiency, economic efficiency, and consumer pocketbooks.and consumer pocketbooks.
In developing countries, In developing countries, farmers often lack power.farmers often lack power.
Example: African countries adopted Example: African countries adopted commodity boards for coffee & cocoa commodity boards for coffee & cocoa at the time of independence. at the time of independence. The original rationale: to buy the crop The original rationale: to buy the crop
in years of excess supply and sell in years in years of excess supply and sell in years of excess demand, thereby stabilizing prices.of excess demand, thereby stabilizing prices.
In practice the price paid to cocoa and coffee In practice the price paid to cocoa and coffee farmers was always below the world price. farmers was always below the world price.
As a result, production fell.As a result, production fell.
Politicians seek to shield consumers Politicians seek to shield consumers via price controls on staple foods & fuel. via price controls on staple foods & fuel.
But the artificially suppressed price But the artificially suppressed price usuallyusually discourages domestic supply, anddiscourages domestic supply, and requires rationing to domestic households.requires rationing to domestic households.
Shortages and long lines can fuel political Shortages and long lines can fuel political rage as well as higher prices can.rage as well as higher prices can.
Otherwise, the policy can require imports Otherwise, the policy can require imports in order to satisfy excess demand, in order to satisfy excess demand,
Thus price controls raise the world price Thus price controls raise the world price even more.even more.
Some food-producing countries use Some food-producing countries use export controlsexport controls to insulate domestic to insulate domestic consumers from a world price rise. consumers from a world price rise.
In 2008, India capped rice exports, In 2008, India capped rice exports, and Argentina did the same for wheat exports, and Argentina did the same for wheat exports, as did Russia in 2010.as did Russia in 2010.
Results: Results: Domestic supply is discouraged.Domestic supply is discouraged. World prices go even higher.World prices go even higher.
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An initiative at the G20 An initiative at the G20 meeting meeting of agriculture ministers in Paris of agriculture ministers in Paris
in June deserved to succeed:in June deserved to succeed: Producing and consuming countries in grain Producing and consuming countries in grain
markets should cooperatively agree to refrain markets should cooperatively agree to refrain from export controls and price controls.from export controls and price controls.
The result would be The result would be lowerlower world price volatility. world price volatility.
One hopes for steps in this direction, One hopes for steps in this direction, working through the World Trade Organization.working through the World Trade Organization.
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Another initiative at the G20 Another initiative at the G20 meeting of agriculture ministers in meeting of agriculture ministers in Paris in June deserved to succeed: Paris in June deserved to succeed:
Bio-fuel subsidies should be eliminated.Bio-fuel subsidies should be eliminated. Ethanol subsidies, such as those paid to Ethanol subsidies, such as those paid to
American corn farmers, do not accomplish American corn farmers, do not accomplish avowed environmental goals, but do divert avowed environmental goals, but do divert grain and so help drive up world food prices.grain and so help drive up world food prices.
So far, the initiative has failed.So far, the initiative has failed. The US is the biggest obstacle.The US is the biggest obstacle.
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The overall lesson for The overall lesson for microeconomic policymicroeconomic policy
Attempts to prevent food prices from fluctuating Attempts to prevent food prices from fluctuating or to insulate consumers generally fail.or to insulate consumers generally fail.
Even though enacted in the name of reducing Even though enacted in the name of reducing volatility and income inequality, volatility and income inequality, their effect is often different.their effect is often different.
Better to accept volatility and cope with it,Better to accept volatility and cope with it, e.g., well-designed transfers to the poor,e.g., well-designed transfers to the poor,
along the lines of Oportunidades or Bolsa Familia.along the lines of Oportunidades or Bolsa Familia.
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III. Back to III. Back to macroeconomics:macroeconomics:
Monetary policy Monetary policy for a food-importing for a food-importing countrycountry
The choice of monetary regime:The choice of monetary regime: Fixed exchange rate or floating?Fixed exchange rate or floating? Inflation Targeting ?Inflation Targeting ? See Frankel (2011) for references.See Frankel (2011) for references.
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Fixed vs. floating exchange ratesFixed vs. floating exchange rates
Fixed exchange rates Fixed exchange rates have many advantages,have many advantages, especially providing especially providing
an anti-inflationary anchor for monetary policy.an anti-inflationary anchor for monetary policy.
But floating exchange rates But floating exchange rates have many advantages too,have many advantages too, especially accommodating trade shocks:especially accommodating trade shocks:
appreciating when the terms of trade improve,appreciating when the terms of trade improve, depreciating when they worsen;depreciating when they worsen; thus automatically stabilizing thus automatically stabilizing
the balance of paymentsthe balance of payments
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FloatingFloating
Bolivia might consider allowing Bolivia might consider allowing more exchange rate flexibilitymore exchange rate flexibility to the extent that the economy to the extent that the economy
is in danger of overheating.is in danger of overheating. Some appreciation – a natural consequence Some appreciation – a natural consequence
of rapid growth and high real interest rates – of rapid growth and high real interest rates – would help hold down inflation.would help hold down inflation.
But then some alternative But then some alternative nominal anchor would be needed,nominal anchor would be needed,
to help meet central banks’ mandate to help meet central banks’ mandate of preventing inflation in the long run.of preventing inflation in the long run.
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Inflation Targeting (Inflation Targeting (ITIT) became ) became the favorite choice of the favorite choice of economistseconomists after the failures of currency pegs after the failures of currency pegs
in the Emerging Market crises of the 1990s. in the Emerging Market crises of the 1990s.
Three South American countries officially adopted Three South American countries officially adopted IT in 1999, in place of exchange rate targets:IT in 1999, in place of exchange rate targets: Brazil, Brazil, Chile, Chile, Colombia.Colombia.
Mexico had done so earlier,Mexico had done so earlier, after the peso crisis of 1994.after the peso crisis of 1994. Peru followed in 2002,Peru followed in 2002, switching from official money targeting. switching from official money targeting. Guatemala officially entered a period of transition to IT, Guatemala officially entered a period of transition to IT,
under a law passed in 2002. under a law passed in 2002.
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It apparently anchored expectations and It apparently anchored expectations and avoided a return to inflation in Brazil, avoided a return to inflation in Brazil, for example,for example, despite two severe challenges: despite two severe challenges: the 50% depreciation of early 1999, the 50% depreciation of early 1999,
(exit from the real plan), and (exit from the real plan), and
the similarly large the similarly large depreciation of 2002, depreciation of 2002, (Lula shock).(Lula shock).
In some ways, In some ways, Inflation Targeting has worked wellInflation Targeting has worked well
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But the 2008-10 global financial But the 2008-10 global financial crisis revealed some drawbacks crisis revealed some drawbacks of of IInflation nflation TTargeting,argeting,
much as the 1994-2001 EM crises much as the 1994-2001 EM crises revealed some drawbacks revealed some drawbacks of exchange rate targeting. of exchange rate targeting.
One vulnerability is asset bubbles.One vulnerability is asset bubbles.
Another is terms of trade changesAnother is terms of trade changes..
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The terms of trade The terms of trade (1)(1)
A worsening of the terms of trade A worsening of the terms of trade can take the form of either:can take the form of either:
(1)(1) A rise in global prices of imports such as food A rise in global prices of imports such as food (2) A fall(2) A fall in the in the globalglobal prices prices of of exportexport commodities.commodities.
(1)(1) A CPI target, interpreted literally, forces A CPI target, interpreted literally, forces the central bank to respond to an increase in $ import the central bank to respond to an increase in $ import prices with a monetary tightening so severe that the prices with a monetary tightening so severe that the currency appreciates in proportioncurrency appreciates in proportion
in order to hold local-currency prices of imports flat.in order to hold local-currency prices of imports flat. It is the It is the oppositeopposite of accommodating the terms of trade, of accommodating the terms of trade, causing likely problems for the balance of payments.causing likely problems for the balance of payments.
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The 4 inflation-targeters The 4 inflation-targeters in Latin Americain Latin America
show show correlationcorrelation ((currencycurrency valuevalue in $in $ ,, import import pricesprices in $in $))
> 0 ;> 0 ;
> correlation before they adopted IT;> correlation before they adopted IT;
> correlation shown by non-IT > correlation shown by non-IT Latin American countries.Latin American countries.
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Table 1: LACA Countries’ Current Regimes and Monthly Correlations of Exchange Rate Changes ($/local currency) with Dollar Import Table 1: LACA Countries’ Current Regimes and Monthly Correlations of Exchange Rate Changes ($/local currency) with Dollar Import Prices Prices
Import price changes are changes in the dollar price of oil.Import price changes are changes in the dollar price of oil.
BOLBOL Other conventional fixed pegOther conventional fixed peg Against a single currencyAgainst a single currency -0.0139-0.0139 0.01560.0156 -0.0057-0.0057
HNDHND Other conventional fixed peg Other conventional fixed peg Against a single currencyAgainst a single currency -0.0203-0.0203 -0.0734-0.0734 -0.0176-0.0176
PRYPRY Managed floatingManaged floating IMF-supported or other monetary programIMF-supported or other monetary program -0.023-0.023 0.34240.3424 0.05430.0543
TTOTTO Other conventional fixed peg Other conventional fixed peg Against a single currencyAgainst a single currency 0.06980.0698 0.20250.2025 0.06980.0698
VENVEN Other conventional fixed peg Other conventional fixed peg Against a single currencyAgainst a single currency -0.0521-0.0521 0.00640.0064 -0.0382-0.0382
* Chile declared an inflation target as early as 1990; but it also had an exchange rate target, under an explicit band-basket-crawl regime, until 1999. * Chile declared an inflation target as early as 1990; but it also had an exchange rate target, under an explicit band-basket-crawl regime, until 1999.
LAC Countries’ Current Regimes and Monthly Correlations of Exchange Rate Changes ($/local currency) with $ Import Price Changes
ITcoun-triesshowcorrel-ations> 0.
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Why is the correlation Why is the correlation between the import price and between the import price and the currency value revealing?the currency value revealing?
Some central banks claim to target Some central banks claim to target corecore CPI, CPI,i.e., excluding volatile food & fuel components.i.e., excluding volatile food & fuel components.
But then the currency of a commodity importer should not But then the currency of a commodity importer should not respond to an increase in the world price by appreciating.respond to an increase in the world price by appreciating.
If anything, floating currencies should If anything, floating currencies should dedepreciate preciate in response to such an adverse terms of trade shock. in response to such an adverse terms of trade shock.
When these IT currencies respond by appreciating instead, When these IT currencies respond by appreciating instead, it suggests that the central bank is tightening monetary it suggests that the central bank is tightening monetary policy to reduce upward pressure on the CPI. policy to reduce upward pressure on the CPI.
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Wanted !Wanted !
New candidate variable for nominal target.New candidate variable for nominal target.
The economic variable should be:The economic variable should be: simpler simpler for thefor the public to public to understand understand exex anteante than core than core CPI, CPI,
and yet and yet robust with respect to supply shocks. robust with respect to supply shocks.
““Robust with respect to supply shocks” Robust with respect to supply shocks” means that the central bank should not have means that the central bank should not have to choose to choose ex postex post between 2 unpalatable alternatives: between 2 unpalatable alternatives: an unnecessary economy-damaging recession or an unnecessary economy-damaging recession or an embarrassing credibility-damaging violation an embarrassing credibility-damaging violation
of the declared target. of the declared target.
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Trade shocksTrade shocks
If the supply shocks are terms of trade shocks, If the supply shocks are terms of trade shocks, then the choice of CPI to be the price index then the choice of CPI to be the price index on which IT focuses is particularly inappropriate. on which IT focuses is particularly inappropriate.
Alternative: an output-based price index Alternative: an output-based price index such as an export price index, the GDP deflator, or PPI;such as an export price index, the GDP deflator, or PPI; My preference: a price index for final sales.My preference: a price index for final sales.
The important difference is that The important difference is that import goods show up in the CPI, import goods show up in the CPI,
but not in the output-based price indices, but not in the output-based price indices, and vice versa for export goods: they show up in and vice versa for export goods: they show up in
the output-based prices but much less in the CPI.the output-based prices but much less in the CPI.
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My proposal – My proposal – Product Price Targeting (PPT):Product Price Targeting (PPT): Call it Call it ITIT, , but target an output but target an output price index instead of CPIprice index instead of CPI
I.e., target a broad index of all domestically produced goods.I.e., target a broad index of all domestically produced goods.
The central bank in practice would not hit the target exactly, The central bank in practice would not hit the target exactly, in contrast to the way it could hit exactly in contrast to the way it could hit exactly
a target for the exchange rate, the price of gold, a target for the exchange rate, the price of gold, or even the price of a basket of 4 or 5 mineral or ag. commodities.or even the price of a basket of 4 or 5 mineral or ag. commodities.
There would instead be a declared band for the PPI target, There would instead be a declared band for the PPI target, which could be wide if desired, just as with the targeting which could be wide if desired, just as with the targeting of the CPI, M1, or other nominal variables.of the CPI, M1, or other nominal variables. Open market operations to keep the price index inside the band Open market operations to keep the price index inside the band
could be conducted in terms of either foreigncould be conducted in terms of either foreign exchange exchange or domesticor domestic securities. securities.
PPT
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One advantage of PPT One advantage of PPT (Product Price Targeting) (Product Price Targeting)
if if foodfood importimport pricesprices
areare volatile.volatile.
It does not let the currency become It does not let the currency become overvalued when import prices rise,overvalued when import prices rise,
as a strict CPI target would.as a strict CPI target would.
PPT
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IV. How do the answers IV. How do the answers change change for a country that also for a country that also exportsexports commoditiescommodities (minerals),(minerals), with with world prices that are equally world prices that are equally volatile?volatile?• If the $ price of mineral exports is highly
correlated with the $ price of food imports, then it is not a terms of trade issue.
• Monetary policy is free to pursue domestic goals of growth and price stability
• which includes tightening/appreciation to prevent overheating.
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Table 2: Major Commodity Exports in LAC countriesand Standard Deviation of Prices on World Markets
Leading Commodity Export* St. Deviation of Log of Dollar Price1970-2008
Bolivia exports a range of minerals and other commodities.
The leading export, natural gas,has the most variable price of all major commodities.
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RANK BY VOLATILITY
Standard
deviation of log of price indices
Country / Region
Terms of Trade (as reported by EIU)
Calculated Terms/ Trade
Export Price Index
in US$Import Price Index in US$
Latin America 0.407 0.407 0.210 0.373
Middle East & N.Afr. 0.291 0.291 0.360 0.246
Main CIS 0.285 0.285 0.437 0.256
Sub-Saharan Africa 0.136 0.136 0.317 0.221
Greater China 0.046 0.046 0.228 0.209
United States 0.042 0.042 0.112 0.149
North America 0.021 0.021 0.125 0.139
Eastern Europe 0.017 0.017 0.247 0.235
Appendix 1: Volatilities of terms of trade, export prices & import prices
Lat.Am. has the highest terms of trade volatility,
-
<= import prices are also volatile
even though oil exporting regions have more volatile export prices.
and not as highly correlated with export prices (as Africa).
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The terms of trade The terms of trade (2)(2)
A worsening of the terms of trade A worsening of the terms of trade can take the form of either:can take the form of either: (1) A rise in global(1) A rise in global prices of importsprices of imports suchsuch asas foodfood (2)(2) A fall in the global prices of exports.A fall in the global prices of exports.
(2)(2) Accommodating the terms of trade Accommodating the terms of trade means allowing the currency to rise or fall means allowing the currency to rise or fall in value along with world prices of the in value along with world prices of the export commodity.export commodity.
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The high volatility of Latin The high volatility of Latin America’s terms of trade makes America’s terms of trade makes it a good candidate for PPT.it a good candidate for PPT.
Recap of advantages:Recap of advantages:
Relative to an exchange rate target,Relative to an exchange rate target, PPT allows accommodation of trade, PPT allows accommodation of trade,
while yet preserving a nominal anchor.while yet preserving a nominal anchor.
Relative to an inflation target,Relative to an inflation target, PPT allows appreciation when price of export PPT allows appreciation when price of export
commodity commodity (minerals)(minerals) goes up, not when price goes up, not when price of import commodity of import commodity (food)(food) goes up – goes up –
whereas a CPI target gets it backwards.whereas a CPI target gets it backwards.
PPT
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The presentation draws The presentation draws on these references by the on these references by the
author author "The Effect of Monetary Policy on Real Commodity Prices"
in in Asset Prices and Monetary Policy, , J.Campbell, ed. (U.Chicago Press, 2008): 291-327. J.Campbell, ed. (U.Chicago Press, 2008): 291-327.
““The Natural Resource Curse: A Survey,”,” forthcoming in in Beyond the Resource CurseBeyond the Resource Curse, B., B.Shaffer, ed., ed. (U.Penn.Press, 2011). (U.Penn.Press, 2011). NBER WP 15836. NBER WP 15836. CID WP195. .
“ “A Comparison of Product Price Targeting and other Monetary Anchor Options, for Commodity-Exporters in Latin America,"" Economia, journal Economia, journal of of LACEALACEA, 2011. , 2011. NBER WP NBER WP 16362..
““Combating Agricultural Price Volatility,”Combating Agricultural Price Volatility,” Project SyndicateProject Syndicate, June 27, 2011. , June 27, 2011.
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AppendicesAppendices
Appendix I:Appendix I:Simulations of the implications of PPT, Simulations of the implications of PPT, compared to 6 other nominal anchorscompared to 6 other nominal anchors
Appendix IIAppendix II Food price graphFood price graph Update of commodity-interest rate testUpdate of commodity-interest rate test
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Appendix IAppendix I
Simulations of ability of PPT Simulations of ability of PPT to stabilize the real prices to stabilize the real prices of traded goods,of traded goods, relative to CPI targetingrelative to CPI targeting or exchange rate targetsor exchange rate targets or historical status quo.or historical status quo.
PPT
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Jamaica
-4
-3
-2
-1
0
1
2
3
4
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
Jamaica, Nominal Aluminium Price(in natural log, mean substracted)
Historic regime
Dollar Peg
SDR Peg
Euro Peg
CPI Target
PPI Target -4.50
-2.50
-0.50
1.50
3.50
5.50
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
Jamaica, Real Aluminium Price(in natural log, mean substracted)
Historic regime
Dollar Peg
SDR Peg
Euro Peg
Comm Peg
CPI Target
PPI Target
Price of aluminum in JamaicaPrice of aluminum in JamaicaSimulations under 6 alternative anchorsSimulations under 6 alternative anchors
1) Any nominal target would have eliminated high 1970s inflation.2) PPI target stabilizes domestic aluminum price better than does CPI.
Table 4: Variability of Export Prices under Table 4: Variability of Export Prices under Alternative Currency RegimesAlternative Currency Regimes(a) Standard Deviation of Nominal Export Prices(a) Standard Deviation of Nominal Export Prices
Standard Deviation of Nominal Export PricesStandard Deviation of Nominal Export Prices
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Begin with a hypothetical peg Begin with a hypothetical peg to theto the $.$.
In the case of Panama, same as historical peg. In the case of Panama, same as historical peg.
In the other cases, we can simulate precisely In the other cases, we can simulate precisely what the price of copper, soy, etc. would have what the price of copper, soy, etc. would have been in terms of pesos under the counterfactual,been in terms of pesos under the counterfactual, by using the historical series for the peso/$ exchange rate: by using the historical series for the peso/$ exchange rate: if the peso historically depreciated against the $ by 1% in some if the peso historically depreciated against the $ by 1% in some
given month, we know the price of copper would have been lower given month, we know the price of copper would have been lower by precisely 1% if the peso had instead been pegged to the $. by precisely 1% if the peso had instead been pegged to the $.
In general, the $ pegs would have produced In general, the $ pegs would have produced far more stable prices in domestic terms.far more stable prices in domestic terms. This is also true of the other 5 nominal anchors, and just illustrates This is also true of the other 5 nominal anchors, and just illustrates
the tremendous price instability experienced in the 1970s & 80s. the tremendous price instability experienced in the 1970s & 80s. ChangesChanges in prices are also more stable under the anchors in prices are also more stable under the anchors (Table 4b).(Table 4b).
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The middle two columns of Table 4a show what The middle two columns of Table 4a show what variability of the commodity export prices would variability of the commodity export prices would have been under an SDR peg or € peghave been under an SDR peg or € peg, , respectively.respectively.
Variability of the domestic price of the commodity export Variability of the domestic price of the commodity export is often lower under the € peg than under the $ peg: is often lower under the € peg than under the $ peg: for natural gas & oil; iron & steel; copper, aluminum & gold; for natural gas & oil; iron & steel; copper, aluminum & gold; bananas & sugar; and soy & beef. bananas & sugar; and soy & beef.
A point often missed by observers who read too much A point often missed by observers who read too much into the $-invoicing of international commodity trade: into the $-invoicing of international commodity trade: Although the use of the $ may introduce some dollar-stickiness Although the use of the $ may introduce some dollar-stickiness
in the very short run, it does not carry over to the medium run. in the very short run, it does not carry over to the medium run. When the effective foreign exchange value of the $ rises, When the effective foreign exchange value of the $ rises,
$ prices of these commodities tend to fall quickly. $ prices of these commodities tend to fall quickly. The offset is not fully proportionate; but the point is that the prices are The offset is not fully proportionate; but the point is that the prices are
not more stable in terms of $ than in terms of €not more stable in terms of $ than in terms of €. .
Table 4(a) shows that in some cases Table 4(a) shows that in some cases (soy, coffee & beef),(soy, coffee & beef), the SDR basket would stabilize commodity prices better the SDR basket would stabilize commodity prices better than either the $ or €. than either the $ or €.
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Comparison in terms of ability to stabilize Comparison in terms of ability to stabilize domestic price domestic price of theof the principle export commodity principle export commodity (Table 4a)(Table 4a) ::
The standard deviation of the domestic price The standard deviation of the domestic price of the export commodity is usually lower of the export commodity is usually lower under PPT than under the CPI target.under PPT than under the CPI target. In a few cases, it is less than half the size: In a few cases, it is less than half the size:
Jamaica for aluminum & Uruguay for beef. Jamaica for aluminum & Uruguay for beef.
ThThe last two columns in the tables: e last two columns in the tables:
comparison of effects of a PPI target & a CPI target,comparison of effects of a PPI target & a CPI target,
which is intended as the contribution which is intended as the contribution of Frankel of Frankel (2011).(2011).
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Stabilizing domestic prices with respect to the Stabilizing domestic prices with respect to the export commodity is far from the only criterion export commodity is far from the only criterion that should be considered in comparing that should be considered in comparing alternative candidates for nominal anchoralternative candidates for nominal anchor . .
Another one is stabilizing Another one is stabilizing domestic prices of domestic prices of otherother tradable goods. tradable goods. A valid critique of PEP was that it transfers uncertainty that A valid critique of PEP was that it transfers uncertainty that
would otherwise occur in the real price of commodity would otherwise occur in the real price of commodity exports into uncertainty in the real price of non-commodity exports into uncertainty in the real price of non-commodity exportables and importables. exportables and importables.
This critique is particularly relevant if This critique is particularly relevant if diversification of the economy is valued.diversification of the economy is valued.
In Table 5 we conduct simulations for In Table 5 we conduct simulations for the domestic prices of the domestic prices of import import goods, goods, under the same seven alternative regimes. under the same seven alternative regimes.
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Table 6 shows implications Table 6 shows implications of theof the alternative alternative regimes, for an objective function regimes, for an objective function that is a weighted average that is a weighted average of of
thethe standard deviation of standard deviation of the real price of the commodity export the real price of the commodity export
andand the standard deviation the standard deviation of of thethe real price real price of theof the import import good. good.
Average of leading commodity export standard deviation & oil price standard deviation.
Table (6c): Standard Deviation of Real PricesTable (6c): Standard Deviation of Real Prices Export Price SD & Import Price SD AveragedExport Price SD & Import Price SD Averaged
Real prices of TGs in generalwould be more stable under PPI target than CPI target.
competition to reduce relative price competition to reduce relative price variabilityvariability
by a margin by a margin when we look at the level of nominal prices when we look at the level of nominal prices (Table 6a)(Table 6a)
or the level of real prices or the level of real prices (Table 6c)(Table 6c) ; and ; and by a smaller margin when we look at nominal price by a smaller margin when we look at nominal price changeschanges (Table 6b).(Table 6b).
The three currency pegs are similar to each other, The three currency pegs are similar to each other,
showing less price variability than the historical regime showing less price variability than the historical regime but more than the commodity peg. but more than the commodity peg.
The PPI target usually gives less relative price variability The PPI target usually gives less relative price variability than the CPI target. than the CPI target. Looking at real price variability in Table 6c, Looking at real price variability in Table 6c,
the only exception is Peru; the only exception is Peru; the gain is substantial in the case of Jamaica and Uruguay, the gain is substantial in the case of Jamaica and Uruguay, smaller for the others.smaller for the others.
PPT
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Appendix II: Appendix II: Recent food prices, Recent food prices, though high, have not been though high, have not been as high as 1974 in real terms.as high as 1974 in real terms.
*) Deflated by US consumer price index.Source: Commodity Research Bureau Spot index Foodstuffs, Datastream.
Nominal prices2010=100
Real prices * = nominal in 2000
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If 2008-2010 is added If 2008-2010 is added to the to the regression of real commodity prices regression of real commodity prices against real interest ratesagainst real interest rates (alone),(alone),
the relationship weakens a bit. the relationship weakens a bit. RR22 falls to .26; falls to .26; Coefficient is -9.4; t-statistic is still -18.6.Coefficient is -9.4; t-statistic is still -18.6.
