Friday, April 11, 2008

Commodities and Recession

The kids at EconBrowser have some interesting observations on commodity prices in the wake of the latest IMF report indicating slowing global economic conditions.

Just as prices for commodities have surprised on the upside over the past couple years (at least I've been surprised, but maybe I've been naive), they may surprise on the downside. Whether they do probably depends upon the source of the spurt in commodity prices. If they are due to loose monetary policy, as suggested by Frankel [1] (manifesting itself in negative real interest rates) and more recently by Jim [2], then high commodity prices should persist as policy becomes expansionary in the Euro Area and the UK (that's my projection, not the IMF's).

If commodity prices are high due to fundamental current demand, then -- given the higly price inelastic nature of both commodity demand and supply -- we might see big drops in prices as the recession takes hold in the US, and the slowdown propagates to the Euro Area and perhaps even to China (in the latter case, a slowdown would be single digit positive growth). (For the IMF's comprehensive analysis of the origins of the commodity price surge, and the implications for the emerging markets and LDCs, see Chapter 5 of the WEO.)

A big hazard that I foresee, then, is the possibility that the commodity exporting country governments acclimate themselves to high revenues at exactly the time revenues decline.

This to me is the crux of the issue -- are commodity prices being sustained by more money or less stuff? I also sympathize with the fear in the last paragraph, especially after the recent political battles here in Argentina. It would be typical of the idiocy of governments to do battle over something that is about to disappear

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