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Commodity Prices, Overshooting, Money Surprises, and Fed Credibility

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Author Info
Jeffrey A. Frankel
Gikas A. Hardouvelis

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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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Publication status: published as Frankel, Jeffrey A. and Gikas A. Hardouvelis. "Commodity Prices, Money Surprises and Fed Credibility," Journal of Money, Credit and Banking, Vol. XVI I, No. 4, Part 2, Nov. 1985, pp. 425-438. J. Frankel. Financial Markets and Monetary Policy. MIT Press, 1995.W
Handle: RePEc:nbr:nberwo:1121

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. 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. [Downloadable!] (restricted)
  2. Frenkel, Jacob A, 1976. " A Monetary Approach to the Exchange Rate: Doctrinal Aspects and Empirical Evidence," Scandinavian Journal of Economics, Blackwell Publishing, vol. 78(2), pages 200-224.
  3. Arthur M. Okun, 1975. "Inflation: Its Mechanics and Welfare Costs," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 6(1975-2), pages 351-402. [Downloadable!]
  4. 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. [Downloadable!] (restricted)
  5. Maurice Obstfeld & Kenneth Rogoff, 1984. "Exchange Rate Dynamics With Sluggish Prices Under Alternative Price-Adjustment Rules," NBER Working Papers 1173, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. 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. [Downloadable!] (restricted)
  7. Maurice Obstfeld & Alan C. Stockman, 1985. "Exchange-Rate Dynamics," NBER Working Papers 1230, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. 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. [Downloadable!]
  9. 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.
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