Commodity Price Changes: Causes and Consequences

Commodity Price Changes: Causes and Consequences Presentation at Food and Inflation: Truth and Consequences A Conference Sponsored by the GIC and the University of Memphis Memphis, Tennessee

Kevin L. Kliesen Federal Reserve Bank of St. Louis February 8, 2012 Not an official document

Outline of Today’s Talk • Commodity Price Trends • What Drives Commodity Prices in the Short and Long Run? • Do Rising Commodity Prices Signal Rising Inflation?

Disclaimer

The views I will express are my own and do not necessarily reflect the positions of the Federal Reserve Bank of St. Louis or the Federal Reserve System.

• Motivation “It was noted that U.S. inflation had been influenced relatively more by commodity price fluctuations in recent years; because commodity prices reflect global economic conditions, U.S. inflation might be less affected by domestic factors and more linked to the global outlook than in the past.”

Minutes of the Nov. 1-2, 2011 FOMC Meeting

• Commodity prices began to increase in 2002 S&P GSCI Commodity Price Indexes Jan. 1990 = 100 700 600

Energy

500

Industrial Metals

400

Prescious Metals Food

300

Livestock

200

Some commodity prices have risen by considerably more than others since 2002: Energy: Ind. Metals: Pr. Metals: Food: Livestock:

365% 178% 507% 161% 69%

100 0 1990

1993

1996

1999

2002

2005

2008

2011

5

• Historically, commodity prices have declined relative to prices of all goods and services Ratio of Commodity Prices to Prices of All Goods and Services

The relative price of commodities is determined by supply/demand fundamentals.

Index, 1947=100 120 100 80

Is the last few years an anomaly or an emerging trend?

60 40 20 0 1947

1954

1961

1968

1975

1982

1989

1996

2003

SOURCE: Commodity Research Bureau and the Bureau of Economic Analysis

2010 6

• Economic Fundamentals 1. Distinguishing between short-run shifts in demand and supply of commodities—often caused by unexpected events (“shocks”) 2. Long-run shifts in supply and demand typically caused by a change in fundamentals

• Possible Explanations for the Commodity Price Boom Since 2002 1. Transitory Developments?

• A weaker dollar • Financialization of commodities • U.S. public policies

2. Longer-lasting Developments •

Strong growth in fast-growing emerging market economies (e.g., China)

• China benefited from an export boom . . . And imported a lot as well Chinese Merchandise Exports and Imports Billions of $US 1,800 1,600 1,400 1,200 1,000

Imports Exports

Ocular econometrics suggests a trend break around 2002—just before China joined the WTO.

800

600 400 200 0 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010

9

• Rapidly rising living standards in the world’s most populous countries Changes in Real Per Capita GDP, Selected Countries Percent change, annual rates 14.0 12.4 12.0

1990-2000

9.5

10.0

2000-2010 8.0

6.0

2010-2016(F)

5.3

3.5

4.0 2.0

As a country’s living standards improve, so does their diet and their production of goods and services.

The result: Increased demand for commodities.

0.0

Brazil

India

China

NOTE: Values in PPP terms; Source is International Monetary Fund

USA 10

• How Long Can the Commodity Price Boom Persist?

– Emerging market economies grow rapidly by applying capital and technology to cheap labor.

– But EMEs are fighting the “Iron Law of Convergence.”

– Rising prices and improving technologies help to mitigate the rapid rise in commodity prices.

– Allowing market forces to allocate resources (via prices) will usually produce the most economically-efficient outcomes.

Do Rising Commodity Prices Signal Higher CPI Inflation?

Accounting for the Facts 12

• Fact #1: The relative weight of food in the consumer basket continues to decline Food in the Consumer Expenditure Basket Relative weight in percent 17.0

Engel’s Law in action.

16.5

This trend parallels the trend we see with energy prices: The economy uses less energy per unit of GDP than, say, 25 years ago.

16.0 15.5 15.0 14.5 14.0 13.5 13.0 12.5 12.0

1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 13

• Fact #2: Food price shocks are large relative to headline and core inflation movements CPI Inflation and Commodity Food Price Changes Percent change from 12 months earlier 80 60

CPI

Core CPI

Food

If you look real close, you might be able to detect some causality.

40 20 0 -20 -40 -60 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011

14

• Fact #3: Energy price shocks appear to have become more important over the past 10 years Correlation Between Commodity Price Changes and Energy Price Changes (12-Mo. Percent changes) 0.7 0.6 0.5

Jan. 1983 to Dec. 2001

0.4 0.3 0.2

Jan. 2002 to Dec. 2011

0.1 0.0 -0.1 Industrial Metals

Precious Metals

Food

Livestock

Prior to 2002, the correlation between energy price changes and food prices was very small.

The correlation between energy prices and livestock price inflation has declined modestly.

15

• Fact #4: Accounting for an apparent trend break in commodity prices S&P GSCI Commodity Price Index Jan. 1990 = 100 900 800 700 600 500 400 300

A broad index of commodity prices exhibited no trend from 1977 to late 2001.

Since early 2002, prices have risen sharply, interrupted by the recession.

200 100 0 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010

16

What do we learn from this table?

1. The correlation between headline and core inflation has declined markedly.

2. The opposite has occurred for commodity prices.

3. Energy and industrial materials appear to be driving the result.

17

What do we learn from this table?

1. The correlation between core inflation and commodity price changes has gone away over the past decade!

2. The same holds for changes in food commodity prices.

3. Changes in the dollar don’t seem to matter for core inflation.

18

To Conclude • The commodity price boom began just after the 2001 recession.

• Changes in commodity prices are influence by a variety of factors—some of which are short-term in nature and some of which reflect structural changes.

• It appears that a key factor explaining the commodity price boom was the rapid growth in China and other emerging market economies (demand factors).

• Commodity prices appear to be reliable for predicting headline CPI inflation but not core inflation.

Questions?

20