The 1981–82 Recession and Non-Oil Primary Commodity Prices
Author: Mr. Ke-young Chu and Mr. Thomas K. Morrison
Publication Date:
01 Jan 1984
eISBN:
9781451956672
Language:
English
Keywords:
SP; commodity price; price; SDR terms; price equation; beverage price fluctuation; price variation; commodity group; Exchange rates; Inflation; Commodity price fluctuations
Download PDF (2.2 MB)

The depressed condition of non-oil primary commodity markets during 1981–82 was the worst since World War II. The overall index of annual average prices of primary commodities (other than gold and petroleum) declined by 12 percent in 1982 (in dollar terms), following a 15 percent decline in 1981. The cumulative two-year decline of 25 percent was the largest and longest in more than three decades. During the last three decades, the largest annual decline occurred during the 1975 recession, when primary commodity prices fell by 19 percent; thereafter, they quickly recovered, increasing by 15 percent in 1976 and by 21 percent more in 1977. Commodity prices in real terms, estimated by deflating nominal prices by the United Nations price index of manufactured exports of developed countries, fell by 20 percent in 1981–82 to a postwar low. Commodity prices increased by 6 percent in 1983, but the aggregate index in 1983 was 20 percent below the previous peak attained in 1980 and 6 percent below the average index for 1977–83.

Abstract

The depressed condition of non-oil primary commodity markets during 1981–82 was the worst since World War II. The overall index of annual average prices of primary commodities (other than gold and petroleum) declined by 12 percent in 1982 (in dollar terms), following a 15 percent decline in 1981. The cumulative two-year decline of 25 percent was the largest and longest in more than three decades. During the last three decades, the largest annual decline occurred during the 1975 recession, when primary commodity prices fell by 19 percent; thereafter, they quickly recovered, increasing by 15 percent in 1976 and by 21 percent more in 1977. Commodity prices in real terms, estimated by deflating nominal prices by the United Nations price index of manufactured exports of developed countries, fell by 20 percent in 1981–82 to a postwar low. Commodity prices increased by 6 percent in 1983, but the aggregate index in 1983 was 20 percent below the previous peak attained in 1980 and 6 percent below the average index for 1977–83.

The depressed condition of non-oil primary commodity markets during 1981–82 was the worst since World War II. The overall index of annual average prices of primary commodities (other than gold and petroleum) declined by 12 percent in 1982 (in dollar terms), following a 15 percent decline in 1981. The cumulative two-year decline of 25 percent was the largest and longest in more than three decades. During the last three decades, the largest annual decline occurred during the 1975 recession, when primary commodity prices fell by 19 percent; thereafter, they quickly recovered, increasing by 15 percent in 1976 and by 21 percent more in 1977. Commodity prices in real terms, estimated by deflating nominal prices by the United Nations price index of manufactured exports of developed countries, fell by 20 percent in 1981–82 to a postwar low. Commodity prices increased by 6 percent in 1983, but the aggregate index in 1983 was 20 percent below the previous peak attained in 1980 and 6 percent below the average index for 1977–83.

The 1981–82 price decline has had a severe impact on the external balance of primary commodity-exporting countries. After declining by about 10 percent during 1978–80, primarily because of the sharp rise in oil prices, the external terms of trade of non-oil developing countries declined by a further 8 percent in 1981–82, notwithstanding the relative stability of oil prices during this period. Combined with a decline in the volume of non-oil exports, these price developments resulted in large aggregate current account deficits of $109 billion in 1981 and $82 billion in 1982, the average of which was almost twice the average annual deficit during 1977–80.1 The low-income developing countries were most adversely affected because of their higher dependence on primary commodities for export earnings.

The sharp decline in commodity prices during 1981–82 was only the most recent indication of a pattern that was first visible in the early 1970s. Although nominal commodity prices sharply accelerated and there were intermittent surges in real prices, the long- term downward trend in real prices from 1972 to 1982 was more than twice as steep as the like price trend from 1957 to 1971. In addition, the price instability2 of non-oil primary commodity prices from 1972 to 1982 was more than three times greater than it was from 1957 to 1971, reflecting the significantly more unstable economic environment—as seen in the behavior of industrial production, world inflation, exchange rates, and interest rates—in the later period. Commodity price instability was one of the major causes of export instability for a large number of primary commodity exporting countries3; export instability, in turn, may have been a major cause of instability in countries’ external balances and domestic economies.4

This paper analyzes the depressed state of primary commodity markets during 1981–82 in the context of developments over a historical period. The causes of primary commodity price movements are investigated, along with the relatively high price in-stability in recent years.

The organization of the paper is as follows: Section I describes the historical movements of non-oil primary commodity prices, focusing on the long-term movements of broadly aggregated prices vis-à-vis the long-term movements of the prices of manufactures and petroleum, and on their short-run fluctuations; Section II analyzes the determinants of commodity prices, including the major causes of commodity price fluctuations over various phases of commodity price cycles; and Section III presents conclusions. Appendix I shows the derivation of the price equation; Appendix II describes the behavior of the variables underlying commodity price movements; Appendix III includes a list of the commodities; and Appendix IV presents some econometric results not reported in the main text.

I. Historical Perspective

long-term developments

Nominal prices

The behavior of primary commodity prices has undergone a significant change since the early 1970s. After exhibiting a high degree of stability—as seen in the small changes in nominal prices—during the two preceding decades, commodity prices have since 1972 exhibited marked cyclical behavior at significantly higher nominal price levels (see Chart 1 and Table 1).5 During 1973 and 1974, the overall commodity price index approximately doubled, with virtually all primary commodities participating in this sharp upward movement. When the world experienced a major recession in 1975, commodity prices fell by 19 percent from the record high level of the previous year. Although this was the largest one-year decline in the last three decades, prices were still 60 percent higher in nominal terms than they had been in 1972.

Chart 1.
Non-Oil Commodity Prices: Long-Term Developments, 1957–83

(1975 = 100)

A04ct01
Table 1.

Indices of Non-Oil Primary Commodity Prices, 1957–831

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Peaks and troughs in deflated prices for the sample period are indicated by bold face type and italic type, respectively.

Expressed in dollar terms.

Deflated by the United Nations index of prices of manufactured exports of developed countries.

As the world economy recovered in 1976 and 1977, commodity prices rose at annual rates of 15 percent and 21 percent, respectively. This rise was temporarily reversed by a 4 percent decline in 1978, which was due entirely to a 37 percent fall in beverage prices; the prices of food, agricultural raw materials, and metals all increased that year. With a recovery in beverages and continuing increases in other commodities, overall commodity prices rose by 16 percent in 1979 and by 9 percent in 1980.

In 1981, with the world entering another recession, commodity prices declined by 15 percent, with every major commodity group participating in this decline. The recession continued into 1982, and commodity prices fell a further 12 percent, in what turned out to be the largest continuous decline in the last three decades.6 Because the dollar appreciated over 1981–82, the cumulative two-year decline in overall commodity prices in SDR terms was about 12 percent, compared with 25 percent in dollar terms.

Since 1957, non-oil primary commodity prices have increased at a rate of 5.1 percent per year (see Table 2). This long-term period, however, is comprised of two rather distinct subperiods: from 1957 to 1971, when prices increased by 0.4 percent annually, and from 1972 to 1982, when prices increased 6.5 percent annually.7 Virtually all commodity groups followed a similar pattern, with the rate of change in food prices increasing from 1.0 percent during 1957–71 to 4.6 percent during 1972–82, in beverage prices from –0.6 percent to 11.1 percent, in agricultural raw materials prices from –1.6 percent to 5.8 percent, and in metal prices from 2.5 percent to 6.6 percent.

Table 2.

Long-Term Price Trends, 1957–821

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The long-term trend is defined as the exponential trend estimated from a semi-log regression of quarterly price on time for each sample period; the rates of change are annualized. The percentage increase for the whole period could therefore be lower or higher than for either 1957–71 or 1972–82.

Expressed in dollar terms.

Deflated by the manufactures price index referred to in footnote 5.

Oil price is the weighted average of the official prices of Libya, Saudi Arabia, and Venezuela.

Manufactures price index is the United Nations index of prices of manufactured exports of developed countries.

Real prices

The average annual growth rate of 5.1 percent from 1957 to 1982 in non-oil primary commodity prices was slower than the rates for both oil prices and manufactures prices during the same period. Vis-à-vis oil prices, primary commodity prices fell by 7.4 percent per annum (86 percent cumulatively); vis-à-vis prices of manufactures, they fell by 0.6 percent per annum (14 percent cumulatively) (see Chart 2). The declines in relative prices were particularly notable during 1972–82.

Chart 2.
Index of All Non-Oil Primary Commodity Prices: Nominal and Real1, 1957–83

(1975 = 100)

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1 Deflated by the United Nations price index of manufactured exports of developed countries.

Because the short-run fluctuation of overall manufactures prices has been much milder than that of primary commodity prices, the short-run fluctuation of overall real commodity prices roughly mimicked that of nominal commodity prices. However, there were two notable divergences in their short-term movements: (i) during the 1975 recession, the decline in real prices was much smaller than the decline in nominal prices; and (ii) in 1979–80, although nominal prices increased substantially, real prices hardly rose because inflation of manufactures prices was high.

price instability

Overall price

Perhaps the most salient feature of commodity price behavior since the early 1970s, compared with that during the rest of the postwar period, is the marked increase in price instability. Although this instability is illustrated in Chart 1, it may be useful to investigate further its characteristics. This subsection describes fluctuations around both long-term and medium-term trends.8

In order to examine the behavior of commodity price fluctuations since 1957, the period has been divided into two subperiods, 1957–71 and 1972–82. Although the choice of these two periods is somewhat arbitrary, it is based on an examination of Chart 1 and, as explained later in the subsection entitled “estimation results” in Section II, on the recognition that 1971–72 was the approximate time at which major variables affecting commodity prices became much more unstable.

Primary commodity price instability, measured by the average percentage deviation of the overall index of quarterly prices from their long-term trends, increased more than threefold between 1957–71 and 1972–82 (see Table 3); the instability, measured as the average of the instabilities of individual prices, doubled; and similar conclusions are obtained if instability around the medium-term trend is examined. Oil prices underwent an even greater change in instability, which increased more than fivefold from 1957–71 to 1972–82 measured around long-term trends, and more than tenfold measured around medium-term trends. Prices of manufactures also experienced higher instability, increasing threefold measured around long-term trends and fivefold measured around medium-term trends.

Table 3.

Instability of Primary Commodity Prices in Dollar Terms, 1957–82

(In percent)

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Instability in column (A) is measured by the average of the absolute values of percentage deviations of the quarterly price from the trend: the long-term trend is estimated by the semi-log regression of the quarterly price on time, the medium-term trend by the 19-quarter moving average of the actual price. In estimating the instability around the medium-term trends, 1957–58 and 1981–82 are excluded from the sample years because the 19-quarter moving average of the prices could not be obtained for these years.

Instability in column (B) is the standard error of estimate (in percent) of the semi-log regression.

Figures represent the weighted average of instability indices of all individual non-oil primary commodities, which reflect offsetting price movements not reflected in the aggregate index.

Deflated by the United Nations index of prices of manufactured exports of developed countries.

Unlike other prices, oil prices in nominal terms were relatively stable except in 1973–74 and 1979–80, when they increased sharply; interpretation of the instability index should therefore take into account this particular behavior of oil prices.

The increase in the instability of primary commodity prices in 1972–82 reflects to some extent a sharp increase in the fluctuation of the dollar’s exchange rates vis-à-vis other major currencies. The conclusion that primary commodity prices were markedly more unstable in 1972–82 than in 1957–71, however, will be reached regardless of whether commodity prices are measured in dollar terms, SDR terms, or real terms (i.e., deflated by the United Nations index of prices of manufactured exports of developed countries), although the extent of the increase appears to be smaller when prices are measured in SDR terms or real terms.

Prices of commodity groups

Price instability around long-term trends increased for all major commodity groups after 1971. The index of price instability for food exhibited the largest rise (fourfold), and the subgroup most responsible for this sharp rise was cereals, whose instability more than quadrupled. Price instability for beverages and for agricultural raw materials approximately trebled after 1971, with coffee and cotton experiencing the largest increases. Metal price instability rose by only 30 percent.

Beverage prices were the most unstable in 1957–71 and retained this rank in 1972–82, when beverage price fluctuations were, on average, more than twice as great as the average fluctuations of all commodities. Metal prices, which had been nearly as unstable as beverage prices in 1957–71, were the least unstable of the four commodity groups in 1972–82. Price fluctuations of food and agricultural raw materials, which had been relatively small during 1957–71, both increased sharply after 1971 to occupy the second and third ranks, respectively.

The difference in the relative behavior of metal prices in the two periods is noteworthy. Relative to the other commodity groups, increases in both nominal prices and the degree of instability were significantly smaller after 1971. There were several reasons for these smaller increases. Metal prices’ average growth rate over 1957–71 increased most rapidly, at 2.5 percent, compared with negative or barely positive rates for the prices of other groups. Metal prices rose particularly fast in the early 1960s, encouraging a rapid expansion of capacity during the decade. During the 1960s, output of copper increased by 47 percent, nickel by 93 percent, and aluminum by 127 percent. When rates of metal consumption growth in the 1970s were lower than had been expected, excess capacity developed that limited price increases and contained price instability of metals relative to the other commodity groups that were more subject to supply constraints.

In summary, commodity price instability has been much more pronounced since the early 1970s than it was in the rest of the postwar period. This result holds for virtually all non-oil primary commodities, irrespective of whether the instability is measured around a long-term or medium-term trend, whether prices are denominated in dollars or SDRs, or whether prices are expressed in nominal or real terms.

II. Determinants of Primary Commodity Prices

The decline in non-oil primary commodity prices in 1981–82 reflected both cyclical and trend factors. These factors are analyzed in this section by examining the statistical relationships since 1957 between commodity prices and their (largely demand-side) determinants. The tentative nature of this analysis should be acknowledged, since commodity markets are influenced by a wide range of factors, many of which are not easily quantifiable. 9

price equation

A commodity price equation is derived and estimated for major groups of commodities for various time periods. The main determinants of commodity prices are then analyzed, with particular regard to their relative impacts during the 1975 and 1981–82 world recessions.

In the price equation to be estimated, the aggregate index of the prices of a commodity group is explained by a number of independent variables. In the logarithmic first-difference form, the equation is written as

θ1Δpt=θ0+θ2Δyt+θ3Δpdt–θ4Δedt–θ5Δ2it+θ6st(1)

where the θis (i = 1, 2, …, 5) denote lag polynomials of finite orders, with the variables defined in logarithms as follows:

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The hypotheses underlying the relationships of the above independent variables to commodity prices are as follows. Economic activity is the major demand-side variable that positively affects commodity prices through changes in real income or industrial demand in consuming countries. Inflation in importing countries, unless offset by exchange rate movements, positively influences commodity prices by raising the domestic price of substitutes and perhaps by increasing investor demand as a consequence of inflationary expectations. The movements of the exchange rates of the currencies of importing countries vis-à-vis the dollar affect commodity prices expressed in dollars because changes in relative prices (i.e., commodity prices in domestic currency relative to the prices of substitutes) affect the quantity demanded. Changes in the real rate of interest influence commodity prices by affecting the demand for stocks. Finally, supply shocks can have a significant impact on commodity prices, particularly prices of food and beverages, for which demand is relatively stable but annual supplies are unstable.

Equation (1) can be regarded as the transfer function for the price variable derived by eliminating all endogenous variables but the commodity price variable from a largely demand-oriented system of structural equations describing a competitive world commodity market. A model of the commodity market that would suggest the type of equation presented above is shown in Appendix I of this paper.

In estimating equation (1), this study determines empirically the exact orders of the lag polynomials on the basis of quarterly time series described in the next subsection; the orders of the lag polynomials having thus been determined, the equation is estimated both with and without an equality constraint for the coefficients of Δpdt and – Δedt.10

description of data

The variables in equation (1) are defined in logarithms as follows:

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behavior of variables underlying commodity price movements

Important changes in the environment of commodity trade are summarized in Table 4 and illustrated in Chart 3. The first part of the table shows sharply higher average nominal commodity prices (122, with 1975 = 100) for 1972–82 relative to prices (53, with 1975 = 100) for 1957–71, but the gain for 1972–82 is more than offset by the inflation indicated by the rise in the general price level in industrial countries. Although the rates of increase in economic activity slowed down, the average rates of increase in non-oil primary commodity prices were sharply higher during 1972–82 than during 1957–71, partly as a result of sharply higher world inflation. The average annual rate of increase in industrial production declined from 5.9 percent during 1957–71 to 2.3 percent during 1972–82; but the annual increase in the average WPI for industrial countries rose from 1.4 percent during the former period to 9.5 percent during the latter, and the average annual increase in commodity prices rose from 0.4 percent to 6.5 percent.

Table 4.

Behavior of Variables Affecting Commodity Prices, 1957–82

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The standard error of estimate of the semi-log regression of price (quarterly data) on time, multiplied by 100.

Level of capacity utilization—not index (1975 = 100).

Chart 3.

Non-Oil Commodity Prices and Major Determinants: Percentage Deviations from 19-Quarter Moving Average, 1959–83

(1975 = 100)

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1 A decline indicates an appreciation of the dollar.

The data in the table also help to explain the sharp increase in the instability in commodity prices during 1972–82 compared with 1957–71. The instability of all major variables (economic activity, world inflation, exchange rates, and interest rates) affecting commodity prices was higher during 1972–82 than during 1957–71. See Appendix II for a summary of significant changes in major determinants of commodity prices during the sample period.

estimation results

Equations are estimated for each group of commodities (all commodities, food, beverages, agricultural raw materials, and metals) for three sample periods: from the first quarter of 1958 through the second quarter of 1982, the first quarter of 1958 through the fourth quarter of 1971, and the first quarter of 1972 through the second quarter of 1982. The end of 1971 is used as the point for dividing the whole sample period into two subperiods, because the fluctuation in commodity prices has become substantially greater since 1971.11 A number of important events took place around that time: (i) major currencies began to float in the last quarter of 1971 following the breakdown of the system of fixed exchange rates between major currencies; (ii) oil prices became more unstable beginning in 1972, a development that has had far-reaching effects on the world economy; and (iii) world inflation and economic activity have become sharply more unstable since the early 1970s.

Table 5 summarizes the results of estimation of the price equation in first-difference form for groups of commodities. Weak variables are suppressed, and the estimation is carried out with and without the equality constraint for the variables Δpdt and –Δedt.

Table 5.

Price Equations I, 1958–8211

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The independent variable in all equations is Δpt. The level of statistical significance is indicated by one (95 percent) or two (99 percent) asterisks. D–W denotes the Durbin-Watson statistic; SEE denotes the standard error of estimate; and the numbers in parentheses below the coefficients are t-statistics.

Explanatory power of equations

The results are more satisfactory for 1972–82 than for 1957–71. The adjusted coefficients of determination are higher for 1972–82 than for 1957–71 for all commodity groups. The variables included in the equation explain a substantial proportion of the variations in the rates of change in prices for all commodity groups except beverages. The adjusted coefficients of determination for the whole sample period (1957–82) range from 0.171 for beverages to 0.473 for all commodities with the equality constraint for the coefficients for Δpdt and – Δedt; they range from 0.183 for beverages to 0.495 for all commodities without the constraint. These coefficients of determination are somewhat higher than those obtained in a previous study that used a similar dependent variable but excluded the interest rate and exchange rate as independent variables.12 For 1972–82, the coefficients obtained in the present study range from 0.203 for beverages to 0.522 for all commodities.13

The results are less satisfactory for 1957–71 than for 1972–82, probably because the fluctuations of the demand-side variables were substantially less during the former period than the latter, implying that, in relative terms, supply shocks were more important in determining the fluctuations of commodity prices during the former period than the latter.14 The results suggest that this was probably the case, particularly for the food and the beverage groups.

Effects of major explanatory variables on commodity prices

The model confirms the influences of the level of economic activity, world inflation, and exchange rates on commodity prices. For 1958–82, these variables are highly significant for all groups of commodities. The only exception is the coefficient of the inflation variable, which is not significant for beverage prices; this result may be due to the dominance of supply shocks in the fluctuation of beverage prices.

The elasticity of overall commodity prices with respect to industrial production is estimated at about 2 for 1972–82, higher than the estimated elasticity for 1957–71. As might be expected, the coefficients of the industrial production variables are larger for agricultural raw materials and metals than for food and beverages.

The elasticity of overall commodity prices with respect to inflation is somewhat larger than unity when the absolute values of the coefficients for the inflation (measured in domestic currencies) and exchange rate change variables are constrained to be equal.15 The coefficients vary substantially among commodity groups, ranging from not statistically different from 0 to close to 2.

The role of the dollar exchange rate in the determination of commodity prices expressed in dollars, as indicated in the results of the regressions, is not surprising. The results show that commodity prices have been sensitive to exchange rate changes during 1972–82. The elasticity of overall commodity prices with respect to the U.S. dollar exchange rate vis-à-vis major currencies is estimated to be somewhat greater than unity. The coefficients vary among commodity groups and are significant for all groups except beverages.

The effects of interest rate changes on commodity prices are not sufficiently robust; the results reported in the table are based on the interest rate variable lagged one quarter as an explanatory variable and suggest an inverse relationship, as indicated in the model introduced earlier. However, if the same equations are estimated with the current interest rate variable as an explanatory variable, the estimated coefficients become either positive or weakly negative. The results with a one-quarter lag are strong for agricultural raw materials and metals.16 Notwithstanding these rather inconclusive results, the unusually high real interest rates during 1981–82 may have contributed to the downward pressure on commodity prices by encouraging inventory reductions, just as the predominantly negative real rates of interest during the 1970s may have exerted upward pressure on nominal commodity prices.

The estimated coefficients for supply shocks all have the expected signs; however, the supply shocks, which are quantified as dummy variables that distinguish only those quarters when conspicuous effects of supply shocks occurred, are not dealt with adequately in the model.

The strong negative constant term estimated for all groups of commodities except beverages is also noteworthy. It reflects the effects of the secular drifts of the supply and the demand functions as specified in Appendix I. For example, the supply function specified in equation (5’) does not include variables accounting for long-term expansion of production capacity of primary commodities and the innovations in production technologies. Also, the demand function specified in equation (4) does not include variables accounting for secular drifts in the demand function that could have occurred because of long-term growth in production of synthetic substitutes. The estimated constant term measures the net effects of the secular trends of the omitted variables on commodity prices. In other words, the estimated coefficient suggests that if the expansion in production capacity, innovations in production technologies, and other secular factors occurred as they actually did, while the variables—such as economic activity and relative prices—that are included in the equations did not change, then commodity prices would have declined by more than 2 percent a quarter.17

Other results

The dynamic nature of the equations should be noted: in the equation for all commodities, both the coefficients for the current and lagged economic activity variables are significant; in the food and the beverage equations, only the lagged economic activity variable is significant; and in the beverage and the agricultural raw material equations, the lagged dependent variables are significant for some periods.18 There is some indication that for beverages and agricultural raw materials, the responses of commodity prices to changes in the explanatory variables are not instantaneous.

The results indicate that the values of some coefficients changed between the 1958–71 and the 1972–82 sample periods: in virtually all cases, the coefficients of economic activity variables became larger in absolute terms in the latter period than in the former, implying a greater fluctuation of commodity prices in the latter period in response to variations in economic activity.19 A possible explanation for the greater response of commodity prices to changes in economic activity in the 1970s may be that larger absolute upward fluctuations in economic activity result in capacity constraints being reached and larger downward fluctuations succeed in overcoming a ratchet effect that limits downward price movements in response to smaller declines in economic activity. The increased use of futures markets in the 1970s may also have resulted in greater responsiveness of commodity prices to underlying real and monetary variables.20

Possible shifts of the coefficients between the two subperiods (1958–71 and 1972–82) have been tested separately for each coefficient, with the maintained hypothesis that all other coefficients have remained the same during the entire sample period.21 The tests suggest that the coefficient of economic activity shifted after 1971 for all commodities, beverages, and agricultural raw materials. No strong evidence is obtained for any other coefficient (see Table 6).

Table 6.

Price Equations II, 1958–821

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The dependent variable in all equations is Δpt. The level of statistical significance is indicated by one (95 percent) or two (99 percent) asterisks. The variables dt and dt-1 are dummy variables that are assigned values of either 0 (for 1958–71) or 1 (for 1972–82). D-W denotes the Durbin-Watson statistic, and SEE denotes the standard error of estimate.

comparison with other studies

Other studies have developed and tested various models of commodity price determination. Like the present study, all of these studies analyze prices of groups of commodities except for the two studies by Hwa (1979 and 1981), which analyze six individual commodities. Unlike the present study, however, most of these studies use the relative price of commodities vis-à-vis manufactures as the dependent variable, except for Hwa (1979 and 1981) and Enoch and Panic (1981), who use changes in the nominal price of commodities. The positive relationship between world economic activity and non-oil primary commodity prices has been well established; all of these studies obtained significant results for this relationship. The price of manufactured exports was shown to be positively related to commodity prices in one study (Enoch and Panic (1981)), and the price of oil and oil price shock dummy variables had significantly positive coefficients in other studies (Enoch and Panic (1981) and Grilli and Yang (1981)). In all these studies, however, the exchange rate variable was not tested separately. Inflationary expectations were shown to be positively related to the prices of several individual commodities (Hwa (1979)). One study also found that the level of the interest rate—not the change in the interest rate that is used in the present study—is negatively related to commodity price movements, especially for metals and agricultural raw materials (Grilli and Yang (1981)), but one found insignificant results (Enoch and Panic (1981)). Supply-side variables (such as production of a commodity or group of commodities, and stocks) that were introduced in several studies showed the expected inverse relationship to commodity prices (Bosworth and Lawrence (1982), Cooper and Lawrence (1975), Hwa (1979 and 1981)). Finally, one study found that commodity prices are positively related to exchange rate variability (Grilli and Yang (1981)). The present study tests the level of the exchange rate, not its variability, as a determinant of commodity prices.

factors underlying instability of commodity prices

Table 7 illustrates how the historical movements of the major explanatory variables identified in this study can help trace the short-term fluctuations in commodity prices. 22 The variance of the rate of change in overall commodity prices is estimated at 6.4 for 1958–71; during this period, the variances of the three demand-side variables—industrial production, world inflation, and the exchange rate—are estimated, respectively, at 2.0, 0.2, and 0.2.23 Together with the estimates of the coefficients for these variables presented in Table 6, these estimates of the variances suggest that contributions made by the variations in these three variables to the variation in commodity prices are 1.6, 0.3, and 0.3, respectively, and that about a third of the variations in commodity prices during 1957–71 is accounted for by the variations in the three critical demand-side variables.24 Although the extent to which the variation in the rate of change in commodity prices was explained by the variations in the three variables remained the same (at about a third) during 1972–82, the degree of variation in these variables was sharply higher in 1972–82 than in 1958–71 (see Table 7). The variance of the rate of change in commodity prices was about nine times greater during 1972–82 than during 1958–71. The variances for all the demand-side variables were greater in the former period than the latter, but the variance for industrial production was twice as large, while the variance for the inflation rate was more than 12 times larger; the instability was greater for both wholesale prices and the exchange rate, but it was much greater for the latter. At the same time, the variance of the random disturbance term, reflecting, among other factors, production shocks that were not exceptional during 1957–71, also became much larger during 1972–82, though its relative contribution to commodity price variation declined substantially.

Table 7.

Factors Underlying Fluctuation of Commodity Prices, 1958–82

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Variance of the quarterly rate of change in percent.

Sum of the variances of the three variables multiplied by the respective coefficients from Table 6 squared.

The error term reflects the significant variables left out of the equation, including production shocks that were not exceptional.

The residual could be either positive or negative, because it reflects covariances between the explanatory variables included in the equation.

Table 8.

Indices of Commodity Price Instability and Underlying Factors

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For commodity prices, the instability indices are the standard errors reported in Table 3 (column (B) under the appropriate periods) squared; for underlying factors, the indices are derived in the same manner on the basis of the semi-log regression of a variable (quarterly) on time.

Variances of the quarterly rates of change (in percent).

The fact that the elasticity estimate of the exchange rate variable reported earlier is not far from unity suggests that the increase in instability of the dollar exchange rates vis-à-vis other major currencies was probably not a major cause of the increase in instability of commodity prices in SDRs, as reported in the subsection entitled “price instability” in Section I of this paper.25

The long-term upward trend of nominal commodity prices has been sharply steeper since the early 1970s, reflecting higher world inflation, while the longer-term downward trend of real commodity prices has also been steeper, reflecting the higher and sustained inflation of manufactures prices, as well as their downward rigidity. The variation in commodity prices has been sharply greater since the early 1970s as a result of greater instability in the economic environment. The preceding analysis has focused largely on the characteristics of commodity price behavior during 1972–82, compared with 1957–71. The analysis therefore has not focused specifically on price developments in very recent years. An examination of the price declines in 1975 and 1981–82 and the price increases preceding the declines will help illustrate how changes in the underlying and following factors studied in this paper influence commodity prices.

comparison of 1975 and 1981–82 recessions

In this section, the commodity price cycle of 1978–83 is analyzed and compared with the previous major price cycle of 1972–77. The commodity price declines of 1975 and 1981–82 were both preceded by relatively large commodity price increases, but the increase preceding 1975 was by far the larger. Although both increases occurred over seven quarters, the cumulative increase preceding the 1975 decline was 131 percent, compared with a 29 percent increase preceding the 1981–82 decline. Movements of the explanatory variables are consistent with the greater strength of the commodity price boom before 1975. Industrial production rose by a cumulative 19 percent in 1972–74, compared with 11 percent for 1979–80; and inflation by a cumulative 40 percent in the former period, compared with 30 percent in the latter. The dollar depreciated by a cumulative 10 percent prior to 1975, compared with no change prior to 1981–82; and the price of oil increased by 382 percent in the former period, compared with 149 percent in the latter (Table 9). The real interest rate (Eurodollar rate) decreased by 10 percentage points prior to 1975, compared with an increase of 11 points in 1979–80, an observation that also is consistent with a stronger commodity price boom before 1975.

Table 9.

Commodity Prices and Their Major Determinants: Changes During the 1972–77 and 1978–83 Cycles I

(In percent)

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The analysis of the recovery phase is confined to 1983 because the latest data were available only through the fourth quarter of 1983 at the time of writing.

The periods for the commodity price indices. The Roman numerals following the years denote calendar quarters. For the explanatory variables, the period chosen for various phases of the two cycles are the same as for the commodity prices except for the following: (a) Industrial production, (i) 1975 recession: increase (1971 III-1973 IV); decrease (1974 1-1975 II); and recovery (1975 III-1976 IV). (ii) The 1981–82 recession: increase (1978 1-1980 I); decrease (1980 11–1982 IV). (b) Exchange rate. 1975 recession: increase (1971 11–1974 II).

Deflated by the United Nations index of prices of manufactured exports of developed countries.

Includes the United Kingdom, the Federal Republic of Germany, France, and Italy.