The link between rising commodity prices and inflation
Since the summer of 2020, the prices of many commodities have jumped, some like steel and lumber, to record highs. The figure shows the 12-month percentage changes of four well-known commodity price indexes. Although down from their highs at the start of the year, the average of the four indices through August is up about 38% from the previous year.
The link between changes in commodity prices and changes in the prices consumers pay for goods and services is intuitive: if the price of steel increases, consumers will pay more for durable goods such as motor vehicles. and household appliances, which will tend to increase the measure of inflation that the Fed targets (the Personal Consumer Expenditure Price Index, or PCEPI). So, perhaps unsurprisingly, the surge in commodity prices has occurred alongside rising consumer prices. In July, the PCEPI increased 4.2% from 12 months earlier, the largest 12-month increase since January 1991.
However, as many Federal Reserve officials have pointed out, the rise in inflation this year also reflects other factors generally unrelated to rising commodity prices.1 In particular, the challenges related to the pandemic appear to be key factors. The pandemic was a global event that triggered widespread disruption in supply chains and business operations that affected the prices of many goods and services. A reasonable assumption is that these disruptions will prove to be temporary once the pandemic is over. As a result, this essay reports simple correlations between commodity price indexes and measures of consumer price inflation from January 1995 to December 2019. The statement of correlations over the period of nearly 25 years before the pandemic could be a better indicator of the co-evolution between key consumer price measures. inflation and changes in commodity prices if the effects of the pandemic are temporary.
The table shows the correlations2 between the 12-month percentage changes of four well-known commodity price indexes and the same changes of six PCEPI inflation measures from January 1995 to December 2019. The annex provides more details on these four price indexes raw material. The PCEPI inflation measures are as follows: The aggregate measure is a weighted average of the prices of durable and non-durable goods and services (listed separately). The baseline measure, released by the Bureau of Economic Analysis, excludes food and energy. And the truncated average inflation rate is calculated by the Federal Reserve Bank of Dallas.3
The table has several takeaways. First, changes in commodity prices and overall PCEPI inflation are strongly correlated. The average correlation of the four commodity indices and headline inflation is 0.7. Second, price indexes that have a larger energy component – such as Bloomberg and Goldman Sachs-Standard & Poor’s – are more strongly correlated with headline inflation. This result is valid for all measures of inflation in the table and suggests the energy intensive nature of the production and distribution of a wide range of goods and services.
Third, the average correlation between commodity prices and the prices of PCE product types is highest for non-durable goods (0.70) and lowest for durable goods (0.14). Energy also helps to explain this result, as higher oil prices usually trickle down quickly to consumers in the form of higher gasoline prices. Higher prices for agricultural products can also drive up the prices of non-durable goods such as bread and burgers. However, the commodity price index with the largest agricultural product weight (CRB) also has the lowest correlation with changes in non-durable goods. The relatively high correlation between the price indexes of energy-intensive commodities and the prices of services is also not too surprising, as, for example, higher prices for jet fuel or diesel tend to increase prices. prices that consumers pay for utilities or air fares or shipping services.
Finally, the correlation between changes in commodity prices and core PCEPI inflation is much lower: the average of the four indices is 0.47. The truncated average inflation rate has an even lower average correlation of 0.06 with changes in commodity prices. In fact, the last column shows that the correlation is even negative in one case.
The main conclusion of this analysis is that the prices of commodities which have a relatively high energy component are more strongly correlated with headline inflation than commodity price indices composed mainly of metals or agricultural commodities.
The author thanks Devin Werner for his research assistance.
1 See Waller (2021).
2 The correlation coefficient measures the linear relationship between two variables and ranges from -1 to 1, where -1 indicates a perfect negative relationship, 0 indicates no relationship, and 1 indicates a perfect positive relationship.
3 See https://www.dallasfed.org/research/pce.
Waller, Christopher J. “The Economic Outlook and Monetary Policy,” remarks at the 39th Annual Global Interdependence Center Monetary and Trade Conference, May 13, 2021; https://www.federalreserve.gov/newsevents/speech/waller20210513a.htm.
Annex: Price indices of selected commodities
Bloomberg Commodity Price Index (BCI)
It offers 23 types of commodity futures prices traded on exchanges in five sectors: energy, agriculture, industrial metals, precious metals and livestock.
The prices of raw materials are weighted. In June 2021, gold received the largest weight (11.7%), followed by West Texas Intermediate (WTI) crude oil (9.9%). By sector, energy receives the most weight (36.1%). The weights change every year.
Industrial Materials Price Index from the Foundation for International Trade and Economic Research (FIBER)
It has 15 types of spot prices of raw materials in four sectors: textiles, metals, crude oil and benzene, and miscellaneous like wood and rubber.
The prices of raw materials are weighted. Structured panels (eg plywood) receive the largest weight (9%), followed by scrap copper (8.7%).
SOURCE: Haver Analytics.
Goldman Sachs-Standard & Poor’s Commodity Index (S&P GSCI)
It offers 24 types of commodity futures prices in five sectors: agriculture, livestock, energy, industrial metals and precious metals.
This output-weighted index is designed to reflect the relative importance of the product in world trade. In 2021, WTI crude oil received the highest weight (21.8%), followed by Brent crude oil (16.1%). The total energy weight is 53.9%.
Commodity Research Bureau Spot Commodity Bureau (CRB)
It offers 22 types of spot prices for raw materials in six sectors: industrial metals, textiles, raw materials, food, fats and oils, and livestock. If a spot price is not available, a bid or ask price may be substituted.
It uses the unweighted geometric mean of commodity prices on Tuesdays relative to base period prices.
© 2021, Federal Reserve Bank of Saint-Louis. The opinions expressed are those of the authors and do not necessarily reflect the official positions of the Federal Reserve Bank of St. Louis or the Federal Reserve System.
Federal Reserve Bank of Saint-Louis published this content on September 08, 2021 and is solely responsible for the information it contains. Distributed by Public, unedited and unmodified, on 08 September 2021 03:11:07 PM UTC.