US monetary policy and sectoral commodity prices

Abstract

Using a Structural VAR (SVAR) model, we examine the effects of the monetary policy of the United States on sectoral commodity prices (including the non-fuel commodity prices, food prices, beverage prices, prices of agricultural raw materials, prices of metals and prices of fuel (energy) commodities) and macroeconomic activity. The empirical evidence suggests that a U.S. monetary contraction leads to an immediate rise in the broad commodity price index, which possibly reflects an aggregation bias, greater expected inflation and speculation, high production costs or some overshooting due to overreactions. Then, the response erodes after six quarters as the positive interest rate shock vanishes and higher interest rates and liquidity drainage take traction. Despite this, the aggregate price response masks the existence of significant heterogeneity in the price responses of the different types of commodity sectors. More specifically, a positive interest rate shock leads to: (i) an initial pop in the price returns of the non-fuel commodities, which later reverses path and becomes negative (as in the case of the prices of agricultural raw materials); (ii) a positive and persistent rise in the volatile food prices; (iii) a fall in the beverage prices; and (iv) a persistent reduction in the prices of metals and the prices of energy prices. Our results also remain globally intact with respect to alternative specifications and identification schemes as well as to unconventional monetary policy effects. Similar results are also found when commodity futures prices are used. We conclude that policymakers should recognize the source of sector inflation before embarking on contractionary monetary policy. The design of core inflation targeting is also preferable to headline inflation targeting.