The Economics and Finance of Commodity Price Shocks

Mikidadu Mohammed

• Éditeur: Routledge
• Année: 2021
• ISBN:
  9781000485189
• Édition: 1
• Sujet: Volkswirtschaftslehre
• Sous-sujet: Makroökonomie

The behaviour of commodity prices never ceases to marvel economists, financial analysts, industry experts, and policymakers. Unexpected swings in commodity prices used to occur infrequently but have now become a permanent feature of global commodity markets. This book is about modelling commodity price shocks. It is intended to provide insights into the theoretical, conceptual, and empirical modelling of the underlying causes of global commodity price shocks.

Three main objectives motivated the writing of this book. First, to provide a variety of modelling frameworks for documenting the frequency and intensity of commodity price shocks. Second, to evaluate existing approaches used for forecasting large movements in future commodity prices. Third, to cover a wide range and aspects of global commodities including currencies, rare–hard–lustrous transition metals, agricultural commodities, energy, and health pandemics. Some attempts have already been made towards modelling commodity price shocks. However, most tend to narrowly focus on a subset of commodity markets, i.e., agricultural commodities market and/or the energy market. In this book, the author moves the needle forward by operationalizing different models, which allow researchers to identify the underlying causes and effects of commodity price shocks. Readers also learn about different commodity price forecasting models.

The author presents the topics to readers assuming less prior or specialist knowledge. Thus, the book is accessible to industry analysts, researchers, undergraduate and graduate students in economics and financial economics, academic and professional economists, investors, and financial professionals working in different sectors of the commodity markets. Another advantage of the book's approach is that readers are not only exposed to several innovative modelling techniques to add to their modelling toolbox but are also exposed to diverse empirical applications of the techniques presented.

1 Introduction

DOI: 10.4324/9781003186984-1

The behaviour of commodity prices never ceases to marvel economists, financial analysts, industry experts, and policymakers. Unexpected swings in commodity prices used to occur infrequently but have now become a permanent recurring feature of global commodity markets. This book is about modelling commodity price shocks. It is intended to provide insights into the theoretical, conceptual, and empirical modelling of the underlying causes of global commodity price shocks.

Three main objectives motivated the writing of this book. First, to provide a variety of modelling frameworks for documenting the frequency and intensity of commodity price shocks. Second, to evaluate existing approaches used for forecasting large movements in future commodity prices. Third, to cover a wide range and aspects of global commodity markets including currencies, rare–hard–lustrous transition metals, agricultural commodities, energy, and health pandemics.

Some attempts have already been made towards modelling commodity price shocks. However, most tend to narrowly focus on a subset of commodity markets, for example, agricultural commodities and/or energy. In addition, previous work relies on generalized autoregressive conditional heteroscedasticity (GARCH) models. Although such reliance has provided important insights about whether the level of volatility has increased in tandem with high-price episodes, GARCH models often take the price of the commodity as given and examine volatility using an autoregressive process. Even when the GARCH models are modified to investigate how volatility of commodity price is influenced by other variables, previous studies tend to assume a unidirectional relationship between the price of the commodity in question and other variables. Specifically, the price of the commodity in question is assumed to be endogenous while the variables that influence price movements are treated as exogenous—the exogeneity bias. But this may not be the case since the price of commodities and the variables that influence price movements may potentially be endogenous and causality may run both ways. In this book, I move the needle forward by operationalizing different variants of structural vector autoregressive (SVAR) models, which allow researchers to overcome the exogeneity bias by endogenizing the relationship among variables to identify the underlying causes and repercussions of global commodity price shocks.

Another blinder in previous work is the focus on exchange rates as the best predictor of future commodity prices. This is a bit problematic because exchange rates/currencies can be conceptualized as commodities. Besides, as some of the modelling techniques discussed in the book will show, exchange rates generate and propagate their own direct destabilizing effects on the economy independent of fluctuations in other commodity prices.

A final blinder in previous studies is the overemphasis on the effects of commodity price volatility on gross domestic product (GDP). Studies in this line of research tend to focus on an even narrower commodity market: oil. Comparatively, this book’s wider coverage of macro variables and commodities and its novel conceptual and methodological approaches provide readers a different, more dynamic perspective for effectively identifying and forecasting the underlying causes and repercussions of commodity price shocks. In addition to proposing two new commodity price shock modelling techniques that combine SVAR and autoregressive distributed lag models, the book also introduces a new commodity price forecasting model called the AR4–REA (autoregressive–real economic activity forecasting model) model.

Throughout the book, I present the topics to readers assuming less prior or specialist knowledge. Thus, the book is accessible to industry analysts, undergraduate and graduate students in economics and financial economics, academic and professional economists, investors, and financial professionals working in different commodity markets. Furthermore, the topics discussed in the book have international appeal and will be useful in most countries in the world: developed countries, emerging economies, developing countries, and commodity-dependent importing and commodity-dependent exporting countries. An added advantage to my approach is that readers are not only exposed to several innovative modelling techniques to add to their modelling toolbox but they are also exposed to diverse empirical applications of the techniques presented.

We begin our modelling journey in Chapter 2, where we examine the historical background and the evolution of the theoretical attempts to model commodity price shocks. Chapters 3 through 6 focus on new empirical evidence, derived chiefly from time series econometric techniques regarding the transmission mechanisms of commodity market shocks in the world economy.

Chapter 7 presents alternative commodity price forecasting tools. Price forecasts are used as a guide for policy and for a range of decisions for commercial activities including business plans, budgets, and investment cases. Chapter 8 evaluates the risks associated with commodity price forecasts. The book closes with concluding remarks in Chapter 9 about the lessons, the challenges, and the budding new frontiers in commodity price research for unraveling the ever-growing complexities of commodity markets.

In writing the chapters, I have made every effort to make them both self-contained and linked together chronologically. Beyond the Introduction, readers can proceed in a chronological order or skip to the chapters of specific interest to them.

2 History and theories of commodity price shocks

DOI: 10.4324/9781003186984-2

2.1 Historical background

In the history of economic growth and prosperity, especially for today’s industrialized nations, commodities were always considered nearly ubiquitous. They were not only essential but also abundant and inexpensive. The relative abundance of low-priced commodities such as raw or semi-processed agricultural products (wheat, rye, barley, corn, rice, coffee, sugar, cotton, spices, cattle, and pulp), minerals and metals (copper, zinc, tin, bauxite, iron, steel, gold, and silver), and energy (coal, charcoal, crude oil, petroleum, and petrochemicals) prompted the development of commodity-intensive industries in many countries. For instance, the Industrial Revolution in Great Britain would not have been possible without cheap and abundant coal. Likewise, without abundant cows and hogs, the Hjedding model of butter and bacon production in western Jutland (Denmark) that began in 1882 would not have materialized.¹

In the early 1800s, technological advances in transportation, communication, refrigeration, and production processes for cheap and high-quality steel combined to open up the New World (United States and Canada), Australia, and Ukraine.² By 1920, higher production rates coupled with falling transportation costs allowed farmers and ranchers in the United States, Canada, Argentina, New Zealand, and Australia to bury Europe under heaps of grain and meat.³ After the First and Second World Wars, countries like Great Britain, France, and Germany, which were once largely self-sufficient in energy needs, became increasingly dependent on cheaper imported crude oil.⁴ Other industrial nations like Italy and Japan, which were already dependent on energy imports, greatly increased the extent of their dependence as their economies advanced and their energy demand soared. Even the United States, which had been largely self-sufficient, became one of the world’s largest oil importers in the 1970s.⁵

Since the fall of Constantinople, commodity prices enjoyed relatively long stretches of stability. But as the world reorganized and interdependencies among countries increased, periods of stable commodity prices came to be dotted with occasional commodity shocks.⁶ For instance, in the sixteenth and seventeenth centuries, coffee was mostly popular in selected regions of the world such as Bab el Mandeb and the Horn of Africa. Even when coffee became a staple in Europe in the early 1700s, coffee prices had a long rally until about 1732 when the Dutch, unable to out-trade their British and French rivals, out-cultivated them by transplanting coffee from Yemen to the Dutch West Indies. Only then did coffee prices plunge. With increased competition in coffee production and the plunge in prices, global commerce shifted towards cotton, which also enjoyed quite a good rally from 1738 to the late 1770s when the newly independent United States joined the ranks of top cotton-producing countries. Following the cotton price crash, global commerce once again turned to a new commodity. This time, dried tea leaves from Asia.

Tea had been introduced to Europe in the 1600s but tea culture, especially in England, changed in the nineteenth century. In 1700, only the wealthiest drank tea; at mid-century, most members of the middle class consumed it regularly; by 1800 it was quaffed even on factory floors.⁷ In the late 1770s, although tea production costs in Asia were declining, tariffs helped keep the price rather high. It was not until 1784, when the British government reduced tariffs from 120% to 12.5%, that tea prices began to decline. Sugar would take over from tea as the focus of global commerce only to suffer a major price collapse at the end of the Napoleonic Wars in 1815.⁸

Since the beginning of the twentieth century, economic depressions in Europe and North America have been inextricably linked with global commodity commerce and tariff policies. While there is no evidence of real long-term damage done by the tariff wars – McKinley Tariff of 1890, Bulow Tariff of 1902, Underwood Tariff of 1920, Fordney–McCumber Tariff of 1922, Luther Tariff of 1925, Smoot–Hawley T...

Table des matières

• Cover
• Half Title
• Series Page
• Title Page
• Copyright Page
• Dedication
• Contents
• List of figures
• List of tables
• Acknowledgements
• 1 Introduction
• 2 History and theories of commodity price shocks
• 3 Modelling commodity price shocks
• 4 Commodity price shocks identification
• 5 Effects of commodity price shocks
• 6 Applications
• 7 Commodity price forecasting
• 8 Risks associated with commodity price forecasts
• 9 Conclusion
• Bibliography
• Glossary
• Appendix
• Index