Commodity Modeling and Pricing: Methods for Analyzing Resource Market Behavior

CHAPTER 3

Nonlinear Features of Comovements between Commodity Prices and Inflation

Catherine Kyrtsou

INTRODUCTION

This chapter further investigates the nonlinear feedback relationship found in Kyrtsou and Labys (2006) between U.S. inflation (Bureau of Labor Statistics consumer price index [BLS CPI]) and the primary commodity price index (the BLS producer price index [PPI] component for all primary commodity series). Our goal is to disaggregate the index to the individual commodity level for a group of raw materials prices, including crude oil. Assuming that a nonlinear feedback relationship exists between U.S. inflation and the commodity price index, we examine if individual primary commodity prices also nonlinearly cause inflation and vice versa. We improve on our previous research by employing a new test for nonlinear feedback causality recently developed by Hristu-Varsakelis and Kyrtsou (2006).

BACKGROUND

Why are primary commodity prices so volatile, and why does this volatility affect inflation? For agricultural commodities whose demand is relatively constant (price-inelastic), fluctuations in production resulting from weather variations cause fluctuations in prices. For mineral and energy commodities where supply is relatively fixed (capacity is price inelastic in the short term), fluctuations in international business cycles tend to destabilize commodity demand and hence prices. In the case of the crude oil market, policies designed to decrease or increase production ...