Commodity Prices: Policy Target or Information Variable?

By Garner, C. Alan | Journal of Money, Credit & Banking, November 1989 | Go to article overview
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Commodity Prices: Policy Target or Information Variable?


Garner, C. Alan, Journal of Money, Credit & Banking


Commodity Prices: Policy Target or Information Variable?

The relationship between growth of the monetary aggregates and growth of nominal GNP has become less dependable in the 1980s. Deposit deregulation and large fluctuations in interest rates have produced sharp changes in the income velocity of money. These velocity shifts have, at times, caused the Federal Reserve to miss or modify its money growth ranges. Because of the undependable relationship between money growth and economic activity, some policymakers and economic analysts have argued that the Federal Reserve should pay more attention to commodity price fluctuations. This paper examines the proper role for commodity prices in the formation of monetary policy.

1. Recent Policy Proposals

Commodity price movements tend to precede changes in the general price level for at least two reasons. First, because primary commodities are important inputs into the production of manufactured goods, changes in commodity prices directly affect production costs and the general price level. Second, because many commodity prices are determined in auction markets, commodity prices respond more rapidly than the prices of manufactured goods and services to demand pressures or supply shocks. As a result, speculative purchases and sales of commodities can make commodity price inflation a leading indicator of the general inflation rate.

In the 1980s, some economists have advocated a policy role for commodity prices that differs from the traditional commodity standard. Under these proposals, the monetary authority would use conventional policy instruments to control either a broad commodity price index or the price of gold. Proponents of such a "commodity price rule" claim commodity prices are so closely related to the general price level that achieving the commodity price target would also control the general inflation rate. Unlike the traditional gold standard, the monetary authority would not intervene directly in commodity markets or maintain official commodity stocks. Instead, proponents believe commodity prices are so sensitive to monetary factors that conventional policy instruments, such as open market operations, could keep the commodity price variable within specified bounds.

Recent commodity price proposals have taken various forms. For example, Genetski (1982) recommended that the Federal Reserve be given a "range of discretion" for the growth of the monetary base. This range would, however, change automatically in response to movements of a commodity price index. Reynolds (1982) also advocated stabilizing spot commodity prices, especially the price of gold, and Wanniski (1983) wrote that "the price of gold, not the quantity of money, is the best leading indicator of future inflations and deflations." In contrast, Miles (1984) argued that the Federal Reserve should stabilize two financial auction market prices, a long-term bond yield and commodity futures prices.

Several U.S. policymakers have also supported an expanded role for commodity prices in monetary affairs. These policymakers have not advocated explicit commodity price targets, but have asserted that commodity prices deserve an important informational role. Federal Reserve Governor Wayne Angell (1987, p. 1) proposed a "commodity price guide to adjust short run money growth target ranges." In addition, Governor Robert Heller (1987, p. 14) stated that "paying more attention to commodity prices might help to anchor not only the domestic price level, but result in greater exchange rate stability as well."

Federal Reserve Vice Chairman Manuel Johnson recently said that commodity prices, along with other financial auction market variables, may be useful in evaluating the stance of monetary policy and assessing changes in inflation expectations. Johnson's list of monetary "indicators" also included the yield curve and the exchange rate. According to Johnson (1988, p.

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