The Empirics of Commodity Price Booms and Busts: Macroeconomic Effects and Policy Response

Abstract

Existing literature has relied on economic fundamentals (EFs) to determine commodity price booms and busts. This framework has been unable to account for major economic non-fundamentals (ENFs). This study takes a broader view of major ENFs that expands beyond the traditional demand and supply indicators to evaluate the response of commodity price booms and busts at both aggregate and disaggregate levels. To obtain consistent estimates, this study utilizes the advantages of the dynamic fixed-effect within instrumental variable method as an estimator to evaluate the behavior of 37 agricultural, energy, and metal commodity prices over 1980—2020. Our results indicate that relative to EFs, ENFs are the predominant driving force of commodity price booms and bursts at aggregate levels. In the case of EFs, the demand-side stimulates commodity prices, whereas the supply-side tends to depress them; however, the former effect tends to outweigh the latter effect. However, on the ENFs front, the dollar-denominated variable is one of the most powerful factors behind commodity price soars and bursts. Meanwhile, at the disaggregate level, the impact of EFs and ENFs is in tandem with that of the aggregate-level commodities. However, world uncertainty tends to depress the prices of energy and metal commodities. Our analysis implies that global demand and supply generated booms and busts in commodity prices have macroeconomic effects on both exporting and importing economies. Along with that, policymakers may need to consider the role of the rise and fall in the value of the dollar as well as that of the financialization of commodities, which were found to have a significant effect on commodity price booms and busts. Countries thus need to devise policies that may help moderate the negative effects of world uncertainty and geopolitical risk.