THE question of why commodity prices have been rising must be broken down into several components. First, is the increase merely nominal, or have real commodity prices also been rising? This is complicated by currency fluctuations, which may result in prices rising in some countries and falling in others. I'm going to assume that both real and nominal commodity prices have recently been increasing in most countries (say using a GDP-weighted set of exchange rates).
The second question is whether the increases reflect supply or demand-side factors. If a wide variety of commodity prices increase at the same time, the most likely cause is higher demand. Rising world output might lead to an increase in commodity demand (relative to supply.) In contrast, supply-side problems are usually industry-specific.
The third question is why has the global demand for commodities increased? It's hard to believe that world output has changed enough in recent weeks to explain the rise in commodity prices. More likely, rumours of quantitative easing led to higher future expected output. This would raise future expected commodity prices, and (because of inter-temporal arbitrage) current commodity prices.
Some people have argued that the high commodity prices resulting from monetary stimulus are a sort of supply shock, which might negate the impact of quantitative easing on aggregate demand. I find this rather unlikely. If global commodity prices are rising due to demand-side factors, then we can expect global commodity output to rise in equilibrium. But markets almost certainly would not expect a rise in global commodity output to result from QE2, if the policy was also expected to reduce total output (as commodities are an important input into many products). From the perspective of global economic recovery, higher commodity prices caused by more aggregate demand are good news.
Of course if a country imports many commodities (as does the US) it is possible that the higher commodity prices would be a net drag on the economy. But even in that case it seems unlikely that QE2 would have a contractionary impact, as monetary stimulus also seemed to depreciate the dollar in the foreign exchange markets. Furthermore the US also produces and exports many commodities. Any net losses from higher commodity prices are likely to be swamped by the increase in aggregate demand resulting from lower exchange rates, higher equity prices, and roughly 0.5% higher inflation expectations over the next 5 years.
Other active discussions about this question:
Blame short-run volatility(1)
A signal of future inflation(1)
Emerging markets are importing Fed monetary policy(1)
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Scott Sumner has taught economics at Bentley University for the past 28 years. He earned a BA in economics at Wisconsin and a PhD at Chicago. His research has been in the field of monetary economics, particularly the role of the gold standard in the Great Depression. He had just begun research on the relationship between cultural values and neoliberal reforms, when he got pulled back into monetary economics by the current crisis.
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