Do Commodity Price Shocks Last Too Long for Stabilization Schemes to Work?

AuthorPaul Cashin, Hong Liang, and C. John McDermott
PositionEconomist in the Commodities and Special Issues Division of the IMF's Research Department/Economist in the Commodities and Special Issues Division of the IMF's Research Department/Advisor at the Reserve Bank of New Zealand

    Shocks to world commodity prices can have a profound impact on the economies of both exporting and importing countries. However, the longer it takes for a price shock to reverse itself, the less likely it is that price stabilization schemes will be viable.

Primary commodities account for about 25 percent of world merchandise trade. Both long-term trends and short-term fluctuations in their prices have important consequences for the world economy. On the demand side, commodity markets play an important role in industrial countries, transmitting business cycle disturbances to the rest of the economy and affecting the rate of growth of prices. On the supply side, primary products account for about half, on average, of developing countries' export earnings, and many developing countries derive the bulk of their export earnings from one or two commodities (Table 1).

[ SEE THE GRAPHIC AT THE ATTACHED RTF ]

To reduce the effects of price fluctuations on domestic prices and export revenues, many countries that export primary products have resorted to stabilization schemes (Box 1). However, policymakers need reliable estimates of the magnitude and duration of commodity price shocks when considering countercyclical stabilization policies. Although policy initiatives that smooth national income and consumption may be effective in the face of short-lived price shocks, long-lived shocks call for policies that enable countries to adjust to new income and consumption levels. Using monthly data from the IMF (for the period 1957-98) on the price indices for 44 primary commodities, we calculate the time it usually takes for the effects of price shocks to dissipate (Box 2) and examine the implications of these results for the efficacy of stabilization schemes.

Box 1 Stabilization schemes

Many developing countries have limited recourse to domestic and external financing in the face of fluctuations in world prices for their commodity exports. They have therefore focused their efforts on smoothing commodity export earnings, typically through one or more of the following:

* stabilization of world commodity prices through the exercise of market power by a monopolistic producer or producer cartel or through international commodity agreements;

* stabilization of producer revenues through the use of risk-management instruments;

* stabilization of government revenues through precautionary savings funds;

* compensatory financing; and

* stabilization of domestic producer and consumer prices through variable export taxes or tariffs, agricultural marketing boards, or domestic...

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