Abstract
• BRIC countries liquidity shocks are associated with increases in commodity prices. • G3 liquidity shocks are associated with smaller increases in commodity prices. • BRIC liquidity shocks are significantly connected with global tightening. • However, G3 liquidity shocks are not connected with global tightening. This paper investigates the influence of liquidity in the major developed and major developing economies on commodity prices. Liquidity is taken to be M2. A novel finding is that unanticipated increases in the BRIC countries’ liquidity is associated with significant and persistent increases in commodity prices that are much larger than the effect of unanticipated increases in G3 liquidity, and the difference increases over time. Over 1999–2012 BRIC liquidity is strongly linked with global energy prices and global real activity whereas G3 liquidity is not. The impact of BRIC liquidity on mineral and metal prices is twice as large as that of G3 liquidity. Granger casualty goes from liquidity to commodity prices. BRIC and G3 liquidity and commodity prices are cointegrated. BRIC and G3 liquidity and global output and global prices are cointegrated. We construct a structural factor-augmented error correction (SFAVEC) model.
Highlights
The effect of global liquidity on the prices of commodities, goods and assets has been a focus of recent research. Sousa and Zaghini (2007) find that global excess liquidity signals inflationary pressure at a global level
Positive shocks in BRIC liquidity have much larger effects on energy prices, mineral and metal prices, and raw material prices than do positive shocks in G3 liquidity
Shocks to G3 liquidity did not have a statistically significant effect on global energy prices. It is only on precious metal prices that shocks to G3 M2 have larger effects than shocks to BRIC M2
Summary
The effect of global liquidity on the prices of commodities, goods and assets has been a focus of recent research. Sousa and Zaghini (2007) find that global excess liquidity signals inflationary pressure at a global level. Humphreys (2010) notes that industrialization increases demand for metals substantially and that development in the BRIC economies is a major factor in the boom in metal prices from 2003 to 2008. A structural factor augmented vector error correction (SFAVEC) model is employed in the analysis of the effect of innovations in BRIC liquidity and G3 liquidity on global commodity prices.. A factor augmented dimension to the SVEC model will capture the dynamic of the information provided by many variables to the analysis of short and long run influence of liquidity on global commodity prices, global industrial production, global inflation and global interest rate. In this paper we will construct a structural factor-augmented error correction (SFAVEC) model to estimate the impacts of increases in BRIC and in G3 liquidity on global commodity prices. Given that the model will incorporate principal component variables, cointegration vectors and ordering restrictions it is convenient to discuss the data, variables and cointegration vectors before discussing the SFAVEC model
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