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Factoring Emerging Markets into the Relationship Between Commodities and Global Liquidity

Factoring Emerging Markets into the Relationship Between Commodities and Global Liquidity. Steven Landgraf WPPI Energy and Marquette University Abdur Chowdhury Marquette University USAEE/IAEE North American Conference Tuesday Oct 11 th , 2011. Background .

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Factoring Emerging Markets into the Relationship Between Commodities and Global Liquidity

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  1. Factoring Emerging Markets into the Relationship Between Commodities and Global Liquidity Steven Landgraf WPPI Energy and Marquette University AbdurChowdhury Marquette University USAEE/IAEE North American Conference Tuesday Oct 11th, 2011

  2. Background • Commodity price bubble (2003 – 2008) • Record high oil and natural gas prices • Ultra low interest rates, 2003-2004 • Accelerated EM economic growth • “Financialization” of commodity markets

  3. S&P GSCI Index

  4. Background cont’d • Commodity price recovery post financial crisis (2009- ) • Near-zero interest rate policies in advanced countries • Massive injections of liquidity during the financial crisis (Quantitative Easing). • QE2 (late 2010 to mid 2011)

  5. Background cont’d • Backlash in the media against QE2 • Coincided with run-ups in prices of oil, gold, food, etc. • Roubini: “Wall of liquidity” chasing assets in EMs • Continued strong performance of EMs after 2008 fueled commodity demand • Not much “global” research incorporates BRIC influence

  6. Previous Literature • Frankel (1986, 2008) • Overshooting model • Monetary variables and commodity prices related • Sousa and Zaghini (2004, 2006) • Global monetary shocks have long-run impacts on domestic prices • Rüffer and Stracca (2006) • “Excess liquidity” impacts prices in advanced countries • Belke et. al. (2010) • Expansionary shocks increase relative prices

  7. What is being tested? • Does excess liquidity positively impact commodity prices? • Which effect is more prominent: • Demand channel? • Excess liquidity? • Do the results change if emerging market data is included in the global aggregate?

  8. Two Samples ADV – aggregates 10 advanced economies and the euro zone economies ALL – aggregates the BRIC countries in addition to the countries in ADV

  9. Results Overview • Output (demand channel) impacts commodity prices – robust result • Excess liquidity, interest rate – mixed results • Interest rate – little influence • Shocks to excess liquidity more prominent than shocks to output in ALL – opposite of ADV

  10. Methodology and Variables • Vector Error-Correction • Granger causality • Impulse Response Function (IRF) • Variance Decomposition (VDC)

  11. Data • Log-difference (except interest rate) • Sample: 1995Q2 to 2010Q3 • Sourced mostly from IMF • Supplemented with World Bank data for some BRIC countries • Aggregation methodology follows Sousa and Zaghini (2004) • PPP exchange rates • Commodity Index: S&P GSCI • 66% weighted with energy commodities

  12. Tests • Lag length (Info criterion and LM test) • ADV: 2 • ALL: 3 • Unit root tests: stationary in 1st diff. • Cointegration: tests suggest its presence • Appropriate to use a VEC vs. a VAR • Long-run equilibrium exists between variables

  13. Results – Output • Demand channel (GDP) robustly impacts commodity prices whether or not BRICs are included. • Granger, IRF, VDCs support • Structural relationship between output and commodity prices • Prices also respond positively to positive shocks

  14. Results - Monetary • Neither interest rates nor excess liquidity Granger cause commodity prices • Positive shocks (1 std. dev.) • ADV: increase commodity prices 2 quarters out • ALL: increase commodity prices 6 and 7 quarters out

  15. Monetary impacts - ADV and ALL • VDCs show discrepancies between ADV and ALL • Excluding BRIC data overestimates impact of demand channel and underestimates excess liquidity

  16. Variance in Commodity Prices due to…

  17. ADV: ALL:

  18. ADV: ALL:

  19. Implications BRIC country economies impact commodity prices in a way not captured by using advanced country data Global liquidity shocks have a great impact on prices when country sample is expanded beyond advanced countries Suggests a diminished role of advanced countries in impacting prices

  20. Policy • Central Banks should continue to closely monitor emerging market monetary policy when considering effects on commodity and energy markets • Research coming from a global standpoint should not exclude emerging markets from analyses • Subject to data availability

  21. Limitations • Interest rates not shown to have a measurable impact on commodity prices • Contrasts with the literature • Average a good measure? Some use LIBOR • Relatively low degrees of freedom • Data quality • Evidence of monetary impacts not overwhelming

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