The Double-Edged Sword of Commodity Prices:
High Levels and High Volatility
Resurgent volatility in commodity markets will likely pose economic challenges in coming years even as prices decline.
What's more, volatility in commodity prices also appears to increase the volatility of domestic inflation over the medium term. This can occur, for example, as greater volatility in the price of imported goods passes through to domestic prices and thereby results in more volatile consumer inflation.
The challenges from heightened commodity price volatility come on top of the problems caused by the surge in price levels.
World food commodity prices rose nearly 40 percent in the two years just before Russia’s invasion of Ukraine, and the war propelled prices even higher. Wheat prices jumped 38 percent in March 2022 from a month earlier. Energy prices rose sharply, with natural gas prices in Europe tripling. High energy prices also fed into record prices of commonly used fertilizers for food production.
While international food and energy prices have moderated since their recent peak, they nonetheless remain elevated. Moreover, the surge has contributed to higher consumer prices and led to economic hardship across the globe. Millions of people, especially in poorer countries, are being pushed into food insecurity.
Commodity prices, especially food and energy, have been fluctuating wildly in recent years due to various factors such as the pandemic, the war in Ukraine, and climate change. These price swings not only affected the level of inflation, but also the growth and stability of the global economy. This commodity price volatility harmed economic performance and most countries have tried to mitigate its negative impacts.
The commodity price volatility reduced economic growth by creating uncertainty and disrupting production and consumption decisions. As commodity prices were unpredictable, producers and consumers faced higher risks and costs, which led them to postpone or cancel some of their plans. For example, farmers reduced their planting or harvesting activities due to volatile fertilizer prices, while households cut their spending on food or energy due to volatile consumer prices. This resulted in lower output and income for both sectors.
Second, commodity price volatility amplified inflation swings by affecting both supply and demand factors. On the supply side, commodity price shocks increased the cost of production for many goods and services, which on many occasions was passed on to consumers by increasing prices. On the demand side, commodity price shocks affected consumer expectations and behavior, which led to higher inflation as they anticipated further price increases. For instance, many consumers expected food prices to rise further, and they started to hoard food items, which then created shortages and pushed prices even higher.
Third, commodity price volatility complicated monetary policy by creating trade-offs between inflation and growth objectives. As commodity prices were very volatile, central banks faced a dilemma: whether to raise interest rates to contain inflation pressures or lower interest rates to support growth prospects. Either way, it had undesirable consequences such as lower output or higher inflation expectations. Moreover, commodity price volatility also affected exchange rates and capital flows, which created additional challenges for monetary policy.
The challenges from heightened commodity price volatility came on top of the problems caused by the surge in price levels. World food commodity prices rose nearly 40 percent in the two years just before Russia’s invasion of Ukraine, and the war propelled prices even higher. Wheat prices jumped 38 percent in March 2022 from a month earlier. Energy prices rose sharply, with natural gas prices in Europe tripling. High energy prices also fed into record prices of commonly used fertilizers for food production.
While international food and energy prices have moderated since their recent peak, they nonetheless remain elevated. Moreover, the surge has contributed to higher consumer prices and led to economic hardship across the globe.
Commodity prices are expected to fall by 21 percent this year and remain mostly stable in 2024. The expected decline in prices for 2023 represents the sharpest drop since the pandemic. Energy prices in 2023 are expected to be 23 percent lower than 2022 on average and remain broadly stable in 2024.
The risks to the forecast are tilted to the upside, primarily because many of the factors that have caused shocks to commodity markets in recent times are still present. These factors include possible disruptions in the supply of energy and metals (in part due to trade restrictions), intensifying geopolitical tensions, a stronger-than-anticipated recovery in China’s industrial sector, and adverse weather events. Disappointing global growth is the major downside risk.
