VoxEU Column Financial Markets Monetary Policy

Why so many commodity prices are down in the US, yet up in Europe

Commodity prices have been falling in the US. This column argues that monetary policy has played a determining role in the falling prices trend. Monetary tightening is highly anticipated in the US, which is likely to raise short-term interest rates. At the same time, the ECB and Bank of Japan have enhanced monetary stimulus through quantitative easing. As a result, the dollar has appreciated against the euro and the yen. In this way, commodities can be down in terms of dollars and up in terms of other currencies.

Falling commodity prices

Oil prices plummeted 43% during the course of 2014 – good news for oil-importing countries, but bad news for Russia, Nigeria, Venezuela, and other oil exporters. Some attribute the price drop to the US shale-energy boom. Others cite OPEC’s failure to agree on supply restrictions.

But that is not the whole story. The price of iron ore is down, too. So are gold, silver, and platinum prices. And the same is true for sugar, cotton, and soybean prices. In fact, most dollar commodity prices have fallen since the beginning of the year. Though a host of sector-specific factors affect the price of each commodity, the fact that the downswing is so broadly shared – as is often the case with big price swings – suggests that macroeconomic factors are at work.

Factors driving the prices down

So, what macroeconomic factors could be driving down commodity prices? Perhaps it is deflation. But, though inflation is very low – even negative in a few countries – something more must be going on because commodity prices are falling relative to the overall price level. In other words, real commodity prices are falling.

The most common explanation is the global economic slowdown, which has diminished demand for energy, minerals, and agricultural products. Indeed, growth has slowed and GDP forecasts have been revised downward in most countries.

But the US is a major exception. The American expansion seems increasingly well established, with estimated annual growth even exceeding 4% over the last two quarters. Private employment has risen by more than 200,000 for each of the last ten consecutive months. And, yet, it is particularly in the US that commodity prices have been falling. The Economist’s euro-denominated Commodity Price Index, for example, has actually risen by 4% over the 12 months; it is only the Index in terms of dollars – which is what gets all the attention – that is down 6%.

That brings us to monetary policy, the importance of which as a determinant of commodity prices is often forgotten. Monetary tightening is widely anticipated in the US, with the Federal Reserve having ended quantitative easing in October and likely to raise short-term interest rates sometime in the coming year.

This recalls a familiar historical pattern:

  • Falling real (inflation-adjusted) interest rates in the 1970s, 2002-04, and 2007-08 were accompanied by rising real commodity prices (Barsky and Killian 2002, Frankel 2008, Hamilton 2009, Frankel and Rose 2010).
  • Sharp increases in US real interest rates in the 1980s sent dollar commodity prices tumbling (Frankel and Hardouvelis 1985).

There is something intuitive about the idea that when the Fed ‘prints money’, the money flows into commodities, among other places, and so bids their prices up. But, what, exactly, is the causal mechanism?

Monetary policy and commodity prices

In fact, there are four channels through which monetary policy affects real commodity prices, via the real interest rate (aside from whatever effect it has via the level of economic activity).

  • First, the extraction channel (Hotelling 1931). High interest rates reduce the price of non-renewable resources by increasing the incentive for extraction today rather than tomorrow, thereby boosting the pace at which oil is pumped, gold mined, or forests logged.
  • Second is the inventory channel (Frankel 1986, 2014). High rates also decrease firms’ desire to carry inventories. Think of oil held in tanks.
  • Third, the financialisation channel (Hamilton and Wu 2014). Portfolio managers respond to a rise in interest rates by shifting into treasury bills and out of commodity contracts – which are now an ‘asset class’.
  • Finally, the exchange rate channel (Frankel 2006). High real interest rates strengthen the domestic currency, thereby reducing the price of internationally traded commodities in domestic terms – even if the price has not fallen in foreign-currency terms.

US interest rates did not really rise in 2014, so most of these mechanisms are not yet directly at work. But speculators are thinking ahead and shifting out of commodities today in anticipation of future higher interest rates in 2015; the result has been to bring next year’s price decrease forward to today.

The fourth of the channels, the exchange rate, has already been functioning. The end of quantitative easing in the US has coincided with moves by the ECB and the Bank of Japan in the opposite direction – toward enhanced monetary stimulus through their own versions of QE. The result has been an appreciation of the dollar against the euro and the yen. The euro is down 10 % against the dollar over the last year and the yen is down 13%. That explains how so many commodity prices can be down in terms of dollars and yet up in terms of other currencies at the same time.

A version of this column was published at Project Syndicate.


Barsky, R, and L Kilian (2002), “Do We Really Know That Oil Caused the Great Stagflation? A Monetary Alternative”, in NBER Macroeconomics Annual 2001, Bernanke B and K Rogoff (eds), MIT Press: 137-183.

The Economist (2014), Commodity Price Index, 20 December.

Frankel, J (1986), "Expectations and Commodity Price Dynamics:  The Overshooting Model", American Journal of Agricultural Economics 68, no. 2, May: 344-348.

Frankel J (2008a), "The Effect of Monetary Policy on Real Commodity Prices", Chapter 7 in Campbell, J (ed.) Asset Prices and Monetary Policy, U.Chicago Press: 291-327, and NBER WP 12713. 

Frankel, J (2008b), "An Explanation for Soaring Commodity Prices", VoxEU.org, 25 March.

Frankel, J(2014), "Effects of Speculation and Interest Rates in a “Carry Trade” Model of Commodity Prices", Journal of International Money and Finance, vol.42, April: 88-112.  HKS RWP13-022, HKS Summary, NBER WP 19463.

Frankel J and G Hardouvelis (1985), "Commodity Prices, Money Surprises, and Fed Credibility", Journal of Money, Credit and Banking 17, no. 4, Nov.: 427-438

Frankel J and A Rose (2010), "Determination of Agricultural and Mineral Commodity Prices",  Chapter 1 in Inflation in an Era of Relative Price Shocks, Reserve Bank of Australia: Sydney)  pp. 9-51. 

Hamilton, J (2009), “Causes and Consequences of the Oil Shock of 2007-08”, Brookings Papers on Economic Activity, Spring, pp. 215-259.

Hamilton, J D, and J C Wu (2014), "Risk Premia in Crude Oil Futures Prices", Journal of International Money and Finance, 42, Elsevier, vol. 42: 9-37

Hotelling, H (1931), “The Economics of Exhaustible Resources”, Journal of Political Economy, 39, no. 2, 137-75.

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