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Commodity Prices, Overshooting, Money Surprises, and Fed Credibility

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  • Jeffrey A. Frankel
  • Gikas A. Hardouvelis

Abstract

The general price level does not provide a sensitive indicator of whether monetary policy is tight or loose, because mostprices are sticky. Interest rates are free to move, but they are an ambiguous indicator of monetary policy: one does not know whether changes in the interest rate are due to changes in the expected inflation rate or the real interest rate.Commodity prices provide the ideal sensitive indicator.This paper has two distinct aims. First, a theoretical model of "over-shooting" in commodity markets is presented. A known change in the money supply is shown to cause an instantaneous change in commodity prices that is greater than the proportionate change that describes long-run equilibrium.Second, we take the occasion of the Fed's Friday money supply announcements to test the theory. We find that an unexpectedly large money announcement causes significant negative reactions in prices of six commodities. This supports at once the sticky-price or overshooting view, and the notion that the market has confidence in the Fed's commitment to correct any deviations from its money growth targets.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1121.

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Date of creation: Jan 1986
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Handle: RePEc:nbr:nberwo:1121

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  1. Maurice Obstfeld & Kenneth Rogoff, 1983. "Exchange rate dynamics with sluggish prices under alternative price- adjustment rules," International Finance Discussion Papers 223, Board of Governors of the Federal Reserve System (U.S.).
  2. Grossman, Jacob, 1981. "The "Rationality" of Money Supply Expectations and the Short-Run Response of Interest Rates to Monetary Surprises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 13(4), pages 409-24, November.
  3. Obstfeld, Maurice & Stockman, Alan C., 1985. "Exchange-rate dynamics," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 18, pages 917-977 Elsevier.
  4. Frenkel, Jacob A, 1976. " A Monetary Approach to the Exchange Rate: Doctrinal Aspects and Empirical Evidence," Scandinavian Journal of Economics, Wiley Blackwell, vol. 78(2), pages 200-224.
  5. Bordo, Michael David, 1980. "The Effects of Monetary Change on Relative Commodity Prices and the Role of Long-Term Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(6), pages 1088-1109, December.
  6. Charles Engel & Jeffrey Frankel, 1982. "Why money announcements move interest rates: an answer from the foreign exchange market," Proceedings, Federal Reserve Bank of San Francisco, issue Nov, pages 1-36.
  7. Arthur M. Okun, 1975. "Inflation: Its Mechanics and Welfare Costs," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 6(2), pages 351-402.
  8. Douglas K. Pearce & V. Vance Roley, 1984. "The Reaction of Stock Prices to Unanticipated Changes in Money," NBER Working Papers 0958, National Bureau of Economic Research, Inc.
  9. V. Vance Roley, 1982. "Weekly money supply announcements and the volatility of short-term interest rates," Economic Review, Federal Reserve Bank of Kansas City, issue Apr, pages 3-15.
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