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Economic activity, interest rates, and market speculation are important drivers behind big recent movements in the prices of oil and other mineral and agricultural commodities. That’s one conclusion reached by Jeffrey Frankel, James W. Harpel Professor of Capital Formation and Growth, in his new Harvard Kennedy School (HKS) Faculty Research Working Paper titled “Effects of Speculation and Interest Rates in a ‘Carry Trade’ Model of Commodity Prices.”
Frankel asks, “In particular, what are the roles of monetary policy (via real interest rates), the strength of global activity, inventories, and risk?”
Frankel writes the most standard influence on the price of commodities is the global growth explanation. “Widespread growth in economic activity after 2000 – particularly including the arrival of China and other entrants to the list of important economies…has raised the demand for and price of commodities.”
The second explanation, which is highly popular among the public, writes Frankel, is speculation. But speculation is not necessarily destabilizing. A rise in the spot price generates expectations of a price decline in the future, which may lead participants to sell or short the commodity and thereby dampen the price increase.
Frankel posits that a third explanation for commodity price increases is easy monetary policy. “Real interest rates do indeed appear to be a significant determinant on commodity prices, operating via the demand for inventories.”
“The implication is that monetary easing probably played a role (along with other factors) in the commodity price spikes of 2008 and 2011,” argues Frankel, while also noting, “Even if this conclusion is right, that doesn’t mean that monetary easing was the wrong thing to do or that inflation is a problem currently.”
Jeffrey A. Frankel is the James W. Harpel Professor of Capital Formation and Growth. He directs the Program in International Finance and Macroeconomics at the National Bureau of Economic Research and served at the Council of Economic Advisers in 1983-84 and 1996-99. His research interests include international finance, commodities, currencies, crises, monetary policy, fiscal policy, regional blocs, and international environmental issues.