Commodity Prices, Monetary Policy and Inflation

During the second half of the 2000s, the world experienced a rapid and substantial rise in commodity prices. This shock posed complex challenges for monetary policy, in particular due to the significant increase in food and energy prices, and the repercussions they had on aggregate inflation measures. This paper discusses the role of commodity price shocks in monetary policy in the light of recent episodes of such shocks. It begins by discussing whether monetary policy should target core or headline inflation, and what should be the role of commodity price shocks in setting interest rates. It is argued that there are good reasons to focus on headline inflation, as most central banks actually do. Although core inflation provides a good indicator of underlying inflationary pressures, the evolution of commodity prices should not be overlooked, because of pervasive second-round effects. This paper reviews the evidence on the rise of inflation across countries and reports that food inflation, more than energy inflation, has relevant propagation effects on core inflation. This finding is particularly important in emerging market economies, where the share of food in the consumer basket is significant. The evidence also shows that countries that had lower inflation during the run up of commodity prices before the global crisis had more inflation in the subsequent rise after the global crisis, suggesting that part of the pre-crisis inflationary success may have been due to repressed inflation. This paper also discusses other factors that may explain different inflationary performances across countries.