When Commodity Prices Surge

• Author: Gaston Gelos and Yulia Ustyugova
• Position: an Advisor in the IMF's Institute for Capacity Development, and is an Economist in the IMF's Western Hemisphere Department.

The recent surge in food prices means that many countries are soon likely to face a new round of inflation pressure. A severe drought in much of the United States and eastern Europe and problems in other food-producing countries have reduced crop yields. Prospects for continued deterioration in the supply mean prices are likely to stay high in the near term. Oil prices, too, have picked up, driven by geopolitical risks.

In the current global environment of uncertainty and slow economic growth, high and volatile commodity prices, as in 2008, pose a complex challenge. Policymakers must strive to keep the surge in commodity prices from triggering a sustained overall increase in inflation—that is, to prevent the commodity price shock from passing through to so-called core inflation (inflation stripped of volatile fuel and food prices).

This global environment not only causes policymakers to weigh the appropriate policy response, it also highlights the need to understand which policy frameworks (such as the type of monetary policy pursued and exchange rate approach taken) and structural characteristics—from labor markets to financial markets—help contain the inflationary effects of commodity price shocks. To date, there has been surprisingly little systematic research on this issue.

Myriad questions

Among the dimensions of the policy response to soaring commodity prices are such questions as these: Do countries with more independent central banks or those whose monetary policy targets a specific inflation rate experience lower pass-through of commodity price shocks to domestic inflation—including core inflation? What is the role of an economy’s openness to trade or the level of development of its financial sector in the transmission of international price shocks? How important is the preexisting level of inflation in determining pass-through? To what extent does a country’s governance framework—beyond the institutional features of the monetary regime—influence the impact on inflation? What role does exchange rate flexibility play?

To explore the role of these and other factors, we studied 31 advanced and 61 emerging market and developing economies, using several methodological approaches (Gelos and Ustyugova, 2012). To begin with, we examined how international commodity price swings affected domestic inflation rates across the countries during 2001–10 by estimating the pass-through from international commodity prices to domestic prices and...