Commodity Prices and Global Inflation, Remarks by John Lipsky, First Deputy Managing Director, International Monetary Fund
IMF News, May 8, 2008
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- Published: May 8, 2008
Overview and macroeconomic context
- Broad consensus: global growth is slowing, reflecting asset price declines, financial market turmoil, plus rising energy and commodity prices.
- IMF World Economic Outlook projection: global output growth will slow by a full percentage point in 2008—to about 3¾ percent—and remain at that pace in 2009.
- Headline inflation: global consumer price inflation is now running at an annual pace of nearly 5½ percent, compared with less than 4 percent in recent years.
- Key policy concern: whether higher energy and commodity prices represent a durable relative price shift, are policy-induced distortions, or signal a resurgence in generalized inflation and inflation expectations.
Factors behind recent commodity price developments and global inflation (Findings)
- Demand fundamentals
- Strong growth in emerging and developing economies, led by China and India, has kept demand for energy and commodities robust.
- Emerging and developing economies as a group have accounted for about 95 percent of the growth in demand for oil since 2003.
- Supply constraints and costs
- Oil: supply projections repeatedly revised downward, especially for non-OPEC producers; market estimates suggest average field exploration and development costs doubled, from $5 a barrel in 2000 to $10 a barrel in 2007.
- Oil market sensitivity: dwindling spare capacity and inventories have made prices highly sensitive to supply disruptions and geopolitical events; oil prices pushed to all-time highs in real terms, surpassing their previous 1979 peak by some 16 percent.
- Food: agricultural production costs and transport costs are responding to rising oil prices; temporary factors (droughts, bad harvests) also contributed; by historical standards, real food prices remain well below previous peaks.
- Base metals: prices peaked in May 2007 and fell by 20 percent in the second half of 2007 on slowing manufacturing and inventory recovery; prices have recovered most losses because of supply concerns and, to a lesser extent, the weakening of the US dollar.
- Policy-induced distortions
- Fuel price policies: of a sample of 43 emerging and developing economies, fewer than half allowed full pass-through of the increase in international prices in 2007 compared with three-quarters in 2006.
- Subsidies and price caps hinder price signals that would moderate demand and encourage conservation.
- Oil investment: higher investment in new oil capacity is associated with countries with better investment climates and stronger corporate and sectoral governance.
- Biofuels: IMF estimates suggest increased demand for biofuels accounts for 70 percent of the increase in corn prices and 40 percent of the increase in soybean prices.
- Agricultural productivity and policy: industrial productivity is about 3½ times higher than agricultural productivity in Asia, compared with 2½ times in Latin America and1½ times in non-Asian advanced economies.
- Export restrictions: in rice markets, preliminary estimates suggest export restrictions and resulting panic buying explain about 50 percent of the recent increase in prices.
- Financial and monetary influences
- Preliminary evidence: low interest rates have a statistically significant impact on commodity prices, above typical demand effects.
- Exchange rates: IMF estimates suggest that if the US dollar had remained at its 2002 peak through end-2007, oil prices would have been $25 a barrel lower and non-fuel commodity prices 12 percent lower.
- Easing in US monetary policy has tended to ease monetary conditions in countries with currencies closely linked to the dollar, potentially exacerbating inflation pressures in some Asian and Middle Eastern economies.
Policy challenges and recommended responses
- Overarching goal: restore strong and stable growth accompanied by low and stable inflation through coherent, globally consistent policy responses.
- Structural policy recommendations
- Allow pass-through of international oil prices to domestic prices to promote demand response and conservation, while implementing well-targeted supports for the most vulnerable.
- Foster investment in the oil sector and energy resources by ensuring stable predictable investment regimes, encouraging partnerships between national and international oil companies, and improving data dissemination on demand and supply conditions.
- Reduce protectionism and subsidies aimed at stimulating biofuels production to remove distortions and increase efficiency; promote conservation and energy efficiency policies.
- Improve agricultural policies in emerging and developing countries: upgrade infrastructure, distribution, and storage; expand irrigation systems; redirect subsidies toward high-yield products and key inputs such as fertilizer; phase out subsidized production in advanced countries over time.
- Macroeconomic policy guidance
- United States: policy interest rates reduced significantly; as growth recovers, monitor developments in inflation and inflation expectations; 2008 fiscal stimulus provides demand cushion; new fiscal measures should stabilize key sectors such as housing and the financial system.
- Euro area: sharp rise in inflation and concerns about inflation expectations dampen confidence and spending; inflation outlook central to ECB policy considerations; prospects could shift if expectations remain anchored and slowing growth reduces pressures.
- Japan: core inflation remains very low at 0.1 percent; given uncertain growth prospects, Bank of Japan policy not expected to change soon.
- Emerging economies with currencies closely linked to the dollar and facing overheating: tighten macroeconomic policies in response to generalized inflation pressures.
- China: movement toward a more flexible exchange rate regime could provide greater scope for stabilizing monetary policy action.
- Middle Eastern commodity exporters: target fiscal spending to alleviate supply bottlenecks—particularly infrastructure—that have contributed to inflation pressures.
IMF role, actions, and research priorities
- IMF focus areas (in line with mandate to promote global financial and economic stability):
- Provision of financial assistance and policy advice to countries negatively affected by international price developments; currently in active discussion with 10-15 low-income member countries regarding possible balance of payments financing.
- Economic research to better understand causes of recent energy and food price increases, the effect of financial fundamentals on commodity prices, and the impact of fuel and food prices on overall inflation and the macroeconomic outlook.
- Development of risk management and mitigation tools and strategies for member use.
- Coordination: participation in a UN Secretary General Task Force on Food Prices comprising the Fund, the World Bank, the WTO, and other UN agencies to coordinate international responses.
Concluding assessment
- Many factors behind recent commodity price rises are fundamental and likely to be durable if IMF global growth forecasts are accurate, but they do not inevitably lead to sustained faster inflation.
- Policymakers must guard against the risk that headline inflation boosts inflation expectations or signals generalized overheating; decisive policy responses would be justified if signs of broader inflation pressures emerge.
- A coherent set of policy responses—structural, monetary, fiscal, and international cooperation—will be required, and responsibilities must be shared globally.
Source: International Monetary Fund — Remarks by John Lipsky, First Deputy Managing Director, May 8, 2008