OECD fiscal policies and the relative prices of primary commodities

Nonfuel primary commodity prices fell more than 30 percent in real terms between 1984 and 1990, even though global economic growth was reasonably strong. The collapse of international commodity agreements, rapid increases in supply for some crops, and agricultural policies in industrial countries have been responsible for some of the price decline. But all nonfuel primaries - agricultural and nonagricultural - experienced a sharp decline in real prices. That calls for a more general explanation. The authors investigatehow the relative price of (nonenergy) primary commodities and manufactures depend on fiscal policies in the OECD countries. It has been argued, for example, that expansionary policies in the OECD countries lead to increases in commodity prices. The authors show that it is not sufficient to establish whether policies are expansionary or contractionary; one must define the policy mix to know what impact it has. Previous studies have used partial equilibrium models to examine the link between maroeconomic policies and commodity prices. In those studies as in this one, the main channel of transmission of monetary and fiscal shocks is the interest rate. The authors use a general equilibrium model of the simultaneous determination of the relative price of commodities and the real world interest rate. The model's logic suggests that OECD fiscal expansion increases the real interest rate and reduces the relative price of commodities to equilibrate world labor product, and asset markets. Econometric estimates based on reduced form equations, using annual data since the 1950s, cannot reject the hypothesis that higher fiscal deficits are associated with a lower relative price of commodities. The estimates suggest that when the fiscal deficit of the G-5 rises one percentage point of GDP, the relative price of commodities drops about 2 percent. When the U.S. deficit rises by one percentage point of GNP, the relative price of primary commodities drops about 3 percent. This evidence provides good reason to believe that macroeconomic policies have been responsible for at least part of the little-understood decline in primary commodity prices over the past decade.