Changes in US monetary policy can have significant effects on global markets, including commodity markets. This column analyses the commodity channel of monetary transmission in detail. It finds commodity prices react within days to US monetary policy shocks, particularly for storable commodities. Consequently, the effects of monetary policy through commodity prices create spillover effects on inflation rates in other countries, and spillback effects on domestic inflation. In the face of food and energy shocks, coordinated monetary policy tightening can be a potent tool to mitigate the impacts on imported inflation.
Sharp fluctuations in commodity prices, among other factors, have been blamed for the recent global surge in inflation and its subsequent fall (Figure 1) (Gagliardone and Gertler 2024, Blanchard and Bernanke 2023). Commodity prices, however, are not exogenous with respect to the macroeconomy (see Barsky and Kilian (2002) and Nakov and Pescatori (2010) for seminal contributions). Indeed, part of the recent monetary policy reaction to inflation may have operated through a commodity price channel, as policy actions from major central banks affect global activity and financial conditions, which are typically major drivers of fluctuations in commodity prices. So, how quantitatively important is the commodity price channel of monetary policy—especially US monetary policy—in driving inflation in the US and worldwide?
Figure 1 Headline inflation, month-on-month percentage change, seasonally adjusted
Sources: Haver Analytics; IMF, Primary Commodity Price System; and IMF staff calculations.
Note: Distribution (shaded area) covers countries accounting for 83.9% of world GDP (purchasing-power-parity-weighted).
Among central banks, the Federal Reserve plays a special role. This is because the bulk of cross-border capital flows are denominated in dollars, and US monetary policy is a key driver of the global financial cycle (Miranda-Agrippino and Rey 2020). Changes in US interest rates thus have pronounced repercussions for the rest of the world (Rey 2013). Conceptually, US monetary policy can affect commodity prices through (1) a cost-of-carry channel by affecting the opportunity cost of commodity storage (Deaton and Laroque 1995), (2) a real-economy channel, by affecting current and future commodity consumption, (3) a liquidity-and-portfolio channel, by affecting financial conditions and thus trading liquidity in physical and derivative markets, and (4) an exchange rate channel, as most commodities are traded in dollars. Since monetary policy typically has long lags affecting the real economy, an immediate effect of a monetary policy shock through the real economy channel can work only through expectations and thus only for easy-to-store commodities. In our paper (Miranda-Pinto et al. 2023), we aim to quantify the relative importance of commodities as a possible transmission channel.
The impact of monetary policy surprises on commodity prices
We start by investigating the first link of the transmission channel from US monetary policy shocks to commodity prices. Using local projection methods for the period 1990-2019, we regress the cumulative change in daily commodity prices on a measure of monetary policy shocks (Jarocinski and Karadi 2020, Bauer and Swanson 2023). 1 We find large and heterogeneous responses of commodity prices to US monetary policy shocks: base metals, crude oil, cotton and rubber, beverages, precious metals, and cereals decline by 2.5%, 2%, 1.9%, 1.3%, 1.1%, and 0.8%, after 18 to 24 business days, respectively, following a positive ten basis points shock to the US monetary policy rate (Figure 2). These effects are larger than the change implied by the appreciation of the US dollar (+0.4%) resulting from the monetary policy tightening. Moreover, storable and industrial commodities are the most responsive as implied by the cost-of-carry mechanism. Considering the high frequency of the data and the short horizon of the impulse response function, these effects may reflect in part short-term trading activity of financial investors. Although it is hard to capture the real demand effects of monetary policy in a two-week horizon, forward-looking agents in commodity markets should adjust their positions (i.e. order books and, eventually, commodity stocks) today in expectation of future changes in demand. Taken together, the effects provide more direct evidence on the importance of the exchange rate and cost of carry channels and indirectly support the role of real demand and financial portfolio rebalancing by money managers. A similar analysis to study the effects of ECB monetary policy shocks on commodity prices suggests that, unlike the case of US monetary policy, ECB monetary policy shocks affect oil prices only.
Figure 2 Peak response of commodity price sub-indexes to a ten basis point increase in Fed funds rate
Note: 90% confidence bands reported. The numbers by the box indicate the day of the peak response.
Global spillovers of US monetary policy through commodity prices
To investigate the importance of the commodity-price channel in the transmission of monetary policy to consumer prices, we move to the monthly frequency and extend our analysis from a single equation to a proxy structural vector autoregression (SVAR) which jointly considers the different transmission mechanisms of monetary policy, including the real demand effects, the financial channel, and the commodity price channel. In the spirit of Bernanke et al. (1997), to isolate the role of commodity price in the transmission of monetary shocks to inflation we reestimate the impulse response functions imposing that monetary policy has no effect on commodity prices (oil and food). The proxy-SVAR is estimated separately for 24 countries to analyse the nominal spillovers of US monetary policy. In Figure 3, we report the effects of US monetary policy on countries’ CPI (in blue) over a period of 12 months along with the effect of US monetary policy on countries’ CPI absent the commodity price channel (red) of oil and food prices. For example, a ten basis point increase in the US monetary policy rate induces a 0.1% decline in the headline CPI of Spain, part of which is mediated by the response of oil and food prices. The channel manifests more strongly in advanced economies, in which a lower prevalence of price controls/subsidies could increase the pass-through of commodity prices to final consumer prices.
For a subsample of countries, we explore the impact of the commodity price channel in foreign countries’ core inflation. Over a six month period, the response of oil and food prices accounts for 1.6% of the response of core CPI of the average country to US monetary policy tightening. This suggests that the pass-through to core prices from oil and food is minor.
Figure 3 12-month response of US monetary policy on countries inflation: Oil and food
Note: Blue square represents the peak response of headline CPI to US monetary policy. 68% confidence bands are displayed. The red square represents the response of CPI assuming commodity prices do not react to monetary policy.
Spillback effects to the US economy
As the effects of US monetary policy ripple through the global economy, some of them spill back to domestic variables. We quantify the domestic ramifications of these shocks, particularly those transmitted through commodities. Figure 4 (left panel) shows the combined mediating effect of oil and food commodities. When the commodity price channel of oil and food is shut down, US monetary policy has a smaller effect on US inflation. Specifically, in the absence of responses from oil and food prices, the decline in headline inflation would have been 0.07 percentage points rather than the observed 0.12 percentage points over six months.
Table 1 summarises the relative importance of the spillover and spillback effects of a ten basis point Fed tightening on headline inflation through oil and food commodities. For the average country, the commodity price channel drives around two-thirds of the total spillover effect of US monetary policy on other countries’ headline inflation. The oil price alone contributes 48%. Our results for the US show that the commodity price channel accounts for about 41% of the first six-month effect of US monetary policy on US headline inflation, most of which is channeled through oil prices.
Figure 4 The commodity price channel: Counterfactual impulse response functions for the US economy
Note: The blue line represents the benchmark estimation. The red lines show the responses of inflation under the assumption that oil prices do not react to monetary policy shocks. The yellow line shows the response of inflation under the assumption that commodity prices (oil and food) do not react to monetary policy.
Table 1 Contribution of the commodity price channel to headline inflation
Note: This table presents the relative importance of the commodity price channel to the total effect of US monetary policy on inflation.
Conclusions
The commodity transmission channel of monetary policy demonstrates the intricate interconnectedness of global financial conditions and central bank actions, particularly those of the US Federal Reserve. The prices of storable commodities, behaving akin to asset or equity prices, swiftly react to shifts in these conditions, thereby influencing headline inflation relatively quickly, especially in advanced economies. Consequently, US monetary policy exerts significant spillovers (and spillbacks) through its impact on commodity prices, affecting interest rates and liquidity conditions worldwide. In the face of global energy and food supply shocks, monetary policy emerges as a potent tool for mitigating inflationary pressures, especially as these shocks, being common across countries, will probably trigger a synchronised global monetary policy response. In fact, unlike fiscal subsidies— which may isolate individual economies from the brunt of an energy supply shock but carry adverse externalities—monetary policy tightening, especially when coordinated among energy importers, can effectively mitigate the impact of energy and food price shocks to imported inflation. The synchronised policy rate increases by major central banks in the aftermath of the pandemic and the invasion of Ukraine has, indeed, helped the quick retrench of inflation globally.
Source : VOXeu
