Do the rising commodity prices we have seen in recent years reflect basic supply-and-demand developments in various commodity markets, or are they the fi rst signs of inflation? In practice, it’s not always easy to tell the difference - for the public or policymakers - but fundamentally different they are. Central banks can do nothing about relative commodity price pressures, since central banks do not produce commodities. Likewise, commodity-price shocks do not impair the ability of central banks to control inflation in principle, but they can greatly complicate the task.Inflation (Finance) ; Prices

Owen F. Humpage

English

Research Papers in Economics

ECONOMIC COMMENTARY
Number 2011-08
May 24, 2011
Do Commodity Prices Signal Inﬂ  ation?
Owen F. Humpage
Do the rising commodity prices we have seen in recent years reﬂ  ect basic supply-and-demand developments in various   
commodity markets, or are they the ﬁ  rst signs of inﬂ  ation? In practice, it’s not always easy to tell the difference—for the 
public or policymakers—but fundamentally different they are. Central banks can do nothing about relative commodity-
price pressures, since central banks do not produce commodities. Likewise, commodity-price shocks do not impair the 
ability of central banks to control inﬂ  ation in principle, but they can greatly complicate the task. 
  ISSN 0428-1276
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2006 2007 2008 2009 2010 2011
Oil
Index (2006= 100)
Non-oil 
commodities
Business-cycle peak
Business-cycle trough
Figure 1.  Commodity Prices
Source: Commodity Research Bureau/Haver Analytics.
Commodity prices have been on a sharp upward trajec-
tory since late 2008 (ﬁ  gure 1). Two views of the trend have 
emerged: One sees these price rises as a reﬂ  ection of basic 
supply-and-demand developments in various commodity 
markets. Those developments are associated with events 
such as renewed economic growth, some agricultural sup-
ply disruptions, and political turmoil in the Middle East. 
Economists refer to these price increases as relative-price 
changes. If this view is correct, the price pressures resulting 
from higher commodity prices—painful as they may be for 
consumers—will be transitory and will ultimately promote 
economic efﬁ  ciency. 
Others view commodity prices as the canary in the inﬂ  a-
tion mine. They contend that commodity prices are surging 
because central banks, particularly those in the advanced 
countries, have kept policy too easy for too long. If this 
view is correct, the recent commodity-price pressures 
represent the beginning of an inﬂ  ationary process that will 
eventually spill into all other prices. These price pressures 
will persist as long as monetary policy remains excessively 
easy, and they will prove increasingly difﬁ  cult to correct the 
longer monetary policy remains accommodative. 
The uncertainty and debate about commodity prices arises 
because economists often cannot quickly and reliably 
distinguish underlying inﬂ  ation trends from relative-price 
pressures using a standard price measure, like the CPI. To 
handle this problem, economists construct “core” price indi-
ces. The core CPI, for example, excludes food and energy 
prices because these items are subject to frequent and often 
substantial relative-price changes. Ideally then, the core 
CPI provides a glimpse of inﬂ  ation that is undistorted by 
relative-price changes. 
But relative price shocks can ripple through even the core 
CPI. Such shocks are not conﬁ  ned to energy and agricul-
tural goods alone, and relative-price changes in one or a few 
individual markets can affect the production and distribu-
tion costs of a wide range of other goods and services. An 
alternative measure is the Federal Reserve Bank of Cleve-
land median CPI, which takes the “core” idea to an extreme 
by subtracting out all CPI components each month except 
whichever one shows the median price increase for that 
month (ﬁ  gure 2). Ideally, this abstracts from relative-price 
pressures altogether and provides a quick, more reliable 
measure of underlying inﬂ  ation—“ideally” being the key 
word here. 
This Economic Commentary explains the two views of commod-
ity prices, distinguishing between relative-price pressures 
and inﬂ  ation and explaining how commodity-price pressures 
complicate monetary policy. Relative-Price Pressures 
Consumers—and economists—often cannot easily distinguish 
between relative-price changes and inﬂ  ation on a day-to-day, 
month-to-month, or even on a longer basis. Both sorts of 
price pressures affect standard price measures similarly, but 
they differ fundamentally from each other in an economic 
sense. Relative-price changes arise in modern economies as 
individual prices adjust to supply-and-demand pressures in 
their respective markets, and they convey important infor-
mation about the scarcity of particular goods and services. 
A rising relative price indicates that demand is outstripping 
supply, while a falling relative price denotes just the oppo-
site. Turmoil in the Middle East, for example, has disrupted 
oil supplies and made oil even scarcer, and that has added 
$14 dollars to a barrel in recent weeks. A rising relative price 
induces consumers to conserve on the good in question and 
to look for substitutes. A rising relative price, by increasing 
proﬁ  t opportunities, also entices producers to bring more of 
the good in question to market, if at all possible. In this way, 
relative-price changes transmit information that is vital for 
the efﬁ  cient allocation of resources throughout any market 
economy. Relative prices make market economies work. 
Increases in the prices of commodities—and in the prices of 
domestic goods made with commodities—have two gen-
eral impacts on the users of those items. First, they cause 
consumers and businesses to substitute cheaper alterna-
tives for the higher-priced goods whenever possible. This, 
so-called substitution effect will likely cause the prices of the 
alternative goods to rise, too, and while it might possibly 
also expand the scope of the price increases, the underlying 
competition tends to limit the size of those increases. 
Second, the rise in the prices of commodities and related 
goods reduces consumers’ and businesses’ purchasing 
power, much like a tax. When gasoline and food prices rise, 
consumers have that much less to spend on other things. 
This, so-called income effect ultimately limits the scope of 
price increases, unless, of course, income somehow expands 
along with the price pressures. 
For income to grow continuously in the face of higher 
prices, the Federal Reserve must ease monetary policy. 
Indeed, the Fed often did so in the 1970s, when the income 
effect from sharply higher oil prices threatened to lower out-
put and create unemployment. Easing monetary policy in an 
attempt to minimize output losses can convert a broad-based 
relative-price hike into inﬂ  ation with—at best—uncertain, 
temporary gains to employment and output. Ultimately 
this monetary accommodation can be self-defeating: The 
economy still must adjust to elevated commodity prices if 
commodities remain scarce, and it must confront a higher 
rate of inﬂ  ation to boot. By mid-1980, inﬂ  ation in the 
United States exceeded 13 percent on a year-over-year basis, 
and oil remained in short supply. 
Inﬂ  ation—The Other Price Hike
Inﬂ  ation—one of the most misused words in economics—re-
fers to a decline in consumers’ purchasing power that results 
when a central bank creates more money than the public 
desires to hold. It eventually manifests itself as a rise in all 
prices, as people unload their excess money for goods. If the 
public’s demand for money grows at 3 percent per year on 
average, but the central bank expands the money supply by 
5 percent per year, all prices and wages will eventually rise 
by 2 percent per year. The economy experiences a 2 percent 
rate of inﬂ  ation. 
Inﬂ  ation always results from this monetary mismatch. It has 
nothing to do with dwindling oil supplies, or excessive wage 
demands, or out-of-control medical prices. As a monetary 
phenomenon, inﬂ  ation is always under the control of a 
central bank. 
That said, the speed with which some amount of excessive 
money creation (a monetary impulse) ﬁ  lters through to all 
wages and prices depends on many things. Most impor-
tantly, it depends on the state of people’s expectations about 
inﬂ  ation and the degree of slack in an economy. In times 
when the public generally anticipates inﬂ  ation or when an 
economy is operating at its full capacity, monetary excesses 
can quickly translate into higher prices and wages. For that 
reason, deﬁ  ning inﬂ  ation as some intermediate-term or long-
term path of the CPI is not always helpful. 
While inﬂ  ation will eventually result in a rise in all prices 
and wages, an inﬂ  ationary impulse will not affect prices 
uniformly as it passes through the economy. Contracts and 
informal business arrangements set many prices—especially 
wages—for ﬁ  xed periods of time. Other prices, for example 
commodity prices, adjust more rapidly—sometimes even in 
anticipation of monetary policies. In response to a mon-
etary impulse, commodity prices may even overshoot their 
long-term equilibrium values precisely because the prices of 
other goods and services are slow to respond. Consequently, 
economists often look to commodity prices as precursors of 
general inﬂ  ation trends. 
In contrast to relative-price changes, inﬂ  ation contains no 
information about the relative scarcity of particular goods 
and services. Quite the opposite; the slow, uneven price re-
sponses that an inﬂ  ation impulse causes as it ripples through 
the economy can send false relative-price signals about the 
underlying conditions of markets, which cause consumers 
and businesses to make bad decisions. Because it distorts 
price signals, inﬂ  ation creates inefﬁ  ciencies. This is a key 
reason, but not the only one, why inﬂ  ation can prove cor-
rosive to economic growth. 
Which Is Which?
At present, the prevailing view sees recent commodity-price 
trends as reﬂ  ecting fundamental supply-and-demand devel-
opments in speciﬁ  c markets and not as a precursor of future 
inﬂ  ation. This relatively benign view derives from the close 
correspondence between commodity-price movements and 
real economic growth—that is, commodity-price increases 
make sense given recent economic events. 
Commodity prices rose sharply between 2002 and 2007 pri-
or to the recent worldwide recession (ﬁ  gure 1). During this 
period, economic growth was strong. The strong growth in emerging and developing economies heightened the typical 
cyclical pattern in commodity prices. Inﬂ  ation, however, re-
mained subdued. Oil and non-oil commodity prices then fell 
sharply during the 2007–2009 recession, as world economic 
activity crumpled. Commodity prices began rising rapidly 
again in early 2009 as world economic activity—again led by 
strong growth among emerging and developing countries—
started to recover. Along the way, supply problems among 
select agricultural goods have added to commodity-price 
pressures, and over the past couple of months, the conﬂ  ict in 
the Middle East has given a further kick to oil prices by dis-
rupting supply and raising uncertainty about future supplies. 
While overall measures of consumer prices like the CPI 
have risen sharply in many countries, core price measures 
have remained subdued. To its advocates, this pattern sup-
ports the view that inﬂ  ation is not busting out. 
This prevailing view also sees recent price pressures as transi-
tory; the substitution and income effects will eventually limit 
their rise, and supply will ﬁ  nally increase in response to high-
er prices. As proponents of this view often note, commodity-
price pressures have had little effect on core-price measures 
over the past 25 to 30 years—a period during which monetary 
policy focused on achieving and maintaining price stability. 
As noted, the alternative view sees rising commodity prices 
as a precursor of future inﬂ  ation. Commodity prices adjust 
much more rapidly to price pressures, including expected 
inﬂ  ation, than other types of consumer-goods prices. Advo-
cates of this view suggest that the recent surge in commodity 
prices is a response to the unparalleled, near-global easing 
of monetary policies over the past few years. Liquidity is 
locked up in banks just waiting to surge out as the recov-
ery matures, and forward-looking commodity markets are 
merely getting a jump on the anticipated inﬂ  ation. Although 
commodity-price shocks may have had little effect on core 
inﬂ  ation measures between 1980 and 2000 when monetary 
policy was well behaved, this is no longer the situation. 
Some economists suggest that the initial OPEC oil-price hikes in 
the 1970s were a response to loose U.S. monetary policy and the 
associated dollar depreciation. The alternative view sees the post-
1980 studies as simply not relevant to the current situation.
The Achilles’ heel of the alternative view—the one seeing 
commodity-price patterns as a signal of future inﬂ  ation—is that 
inﬂ  ation expectations remain subdued in general (ﬁ  gure 3). 
Still, they have not been stagnant. Inﬂ  ation expectations have 
ticked up somewhat in recent months. In addition, the median 
CPI has also been increasing at a considerable pace recently 
(ﬁ  gure 1). It has maintained a 2 percent average annual rate—a 
critical clip for many central banks—over the last three months. 
Monetary Policy
Monetary policy can control inﬂ  ation, but it can do noth-
ing about relative commodity-price pressures, since central 
banks do not produce commodities. Likewise, commodity-
price shocks do not fundamentally impair the ability of 
central banks to control inﬂ  ation, but they can greatly com-
plicate the task. They do so in at least three ways. 
First, because commodity markets can sometimes signal inﬂ  ation 
and because people are not able to quickly distinguish inﬂ  ation 
trends from relative-price pressures in the CPI, reading commod-
ity-price patterns can be difﬁ  cult and can lead to errors. 
Second, in an environment of imperfect information, chang-
es in the prices of speciﬁ  c goods—like gasoline and food—
can heighten inﬂ  ation expectations even when inﬂ  ation is 
well contained. As the economy moves toward its potential 
growth path, heightened inﬂ  ation expectations can raise the 
output costs of keeping inﬂ  ation low. 
Third, the income effects of commodity-price shocks put 
downward pressure on real economic growth while putting 
upward pressure on price indexes. This sometimes makes 
tightening monetary policy a politically tough choice. In 
situations like these, central banks need to draw on their 
reputations for maintaining price stability. If that reservoir is 
low, a speciﬁ  c inﬂ  ation target can help. 
Figure 2.  Consumer Prices Figure 3.  Ten-Year Expected Inﬂ  ation
Sources: Federal Reserve Bank of Cleveland; Bureau of Labor Statistics; 
Haver Analytics. Source: Haubrich, Pennacchi, and Ritchken (2008).
–3
–2
–1
0
1
2
3
4
5
6
1991 1994 1997 2000 2003 2006 2009
Consumer Price Index
Annualized percent change
Median CPI
2011
1.0
1.5
2.0
2.5
3.0
3.5
2000 2002 2004 2006 2008 2010
PercentOwen F. Humpage is a senior economic advisor at the Federal Reserve Bank of Cleveland. The views he expresses here are his and not 
necessarily those of the Federal Reserve Bank of Cleveland, the Board of Governors of the Federal Reserve System, or Board staff.
Economic Commentary is published by the Research Department of the Federal Reserve Bank of Cleveland. To receive copies or be placed 
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Recommended Reading
“On the Origins and Evolution of the Word Inﬂ  ation,” by 
Michael F. Bryan. 2006. Federal Reserve Bank of Cleveland, 
Economic Commentary (October 15). 
“Is It More Expensive, or Does It Just Cost More Money?” 
by Michael F. Bryan. 2002. Federal Reserve Bank of Cleve-
land, Economic Commentary (May 15). 
“The Prospects for Inﬂ  ation Ahead,” by Michael Bordo. 
2011. Paper presented at the Shadow Open Market Com-
mittee, New York City, March 25. <http://shadowfed.org/
archives/>
“Commodity Prices, Money, and Inﬂ  ation,” by Frank 
Browne and David Cronin. 2007. European Central Bank, 
working paper no. 738 (March). 
“The Effect of Monetary Policy on Real Commodity Prices,” 
by Jeffrey A. Frankel. 2006. NBER W orking Paper, no. 12713. 
“Do Energy-Price Shocks Affect Core-Price Measures?” by 
Owen Humpage and Eduard Pelz. 2002. Federal Reserve 
Bank of Cleveland, working paper no. 02-15. 
“Do We Really Know That Oil Caused the Great Stagﬂ  a-
tion? A Monetarist Alternative,” by Robert Barsky and Lutz 
Killian. 2002. NBER Macroeconomic Annual 2001, Edited by 
Ben S. Bernanke and Kenneth Rogoff.”
“Estimating Real and Nominal Term Structures Using Trea-
sury Yields, Inﬂ  ation, Inﬂ  ation Forecasts, and Inﬂ  ation Swap 
Rates,” by Joseph G. Haubrich, George Pennacchi, and Peter 
Ritchken. 2008. Federal Reserve Bank of Cleveland, working 
paper no. 08-09 (November). 
On the Web
The Median CPI: Data and Background. <www.cleveland-
fed.org/research/data/us-inﬂ  ation/about_mcpi.cfm>
Inﬂ  ation Expectations, Data and Background. <www.cleve-
landfed.org/research/data/inﬂ  ation_expectations/index.cfm>

Do commodity prices signal inflation?

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Do commodity prices signal inflation?

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