SCHWEIKERT:  Would you be willing to share -- because, for every positive side, there's often some negatives -- what you would say would be the dampening or some of the costs into the economy of the fairly rapid monetary expansion?

BERNANKE: Well, I think -- I think the main one is that there has been some contribution to commodity prices, which we anticipated. Again, I think that supply and demand factors globally were by far the more important. But that increase in commodity prices offset some of the benefits that, you know, that lower interest rates and more accommodative financial conditions have for -- for growth and for addressing the risks of deflation, which we saw in -- last August.

SCHWEIKERT: The inflationary pressures you saw on many commodity classes -- were they within the range you expected?

BERNANKE: No, they were much larger, but because -- because the -- again, the bulk of those movements are -- can be attributed, and quite directly -- and I recently gave a speech that went through some detail on this issue, to global supply and demand conditions.

Although commodity standards were last discussed when U.S. inflation was high and variable, Bullard noted that today, inflation is quite low.  He added, “Tying the currency to commodities when commodity prices are highly variable is questionable.” 

While a commodity standard forces accountability on the central bank, “it did not always work because governments sometimes changed the rate between the commodity and the currency,” Bullard said.  “Inflation targeting is another way to force more accountability to the central bank and anchor longer-term expectations.   Make the central bank say what it intends to do,” he said, “and hold the central bank accountable for achieving the goal.” 

“Inflation targeting,” Bullard concluded, “is the appropriate modern alternative to historical commodity standards.”

 The Committee's aggressive monetary easing was not without risks.  During the early phase of rate reductions, some observers expressed concern that these policy actions would stoke inflation.  These concerns intensified as inflation reached high levels in mid-2008, mostly reflecting a surge in the prices of oil and other commodities.  The Committee takes its responsibility to ensure price stability extremely seriously, and throughout this period it remained closely attuned to developments in inflation and inflation expectations.  However, the Committee also maintained the view that the rapid rise in commodity prices in 2008 primarily reflected sharply increased demand for raw materials in emerging market economies, in combination with constraints on the supply of these materials, rather than general inflationary pressures. 

In industrialized economies, such as the United States, rising inflation has chiefly reflected the surge in energy prices, whereas in developing countries, for which food takes up more of household budgets, rising food costs have been a more important culprit. The reasons for the trajectory and persistence of increases in prices of food and energy this year, as global growth has moderated, are not entirely clear. The upward trend in prices of food and energy over the past several years, however, importantly reflects the pressures posed by rapidly growing demand in developing economies against relatively inelastic global supplies of commodities.

I believe that consideration has to be given to the hypothesis that different forces have driven the relative prices of food and energy in the recent past—namely, shifts in demand in world markets. These forces are likely to persist for some time. In particular, I have in mind rapid increases in standards of living in large emerging-market economies. Associated with these increases in living standards are higher consumption of calories and higher consumption of energy and thus increasing demand in the global markets for these products. With low short-run elasticity of supply for food and energy production, these trends in demand generate trends in relative prices.

The results of such exercises imply that, over recent history, a sharp jump in oil prices appears to have had only modest effects on the future rate of inflation. This result likely reflects two factors.  First, commodities like oil represent only a small share of the overall costs of production, implying that the magnitude of the direct pass-through from changes in such prices to other prices should be modest, all else equal. Second, inflation expectations have been well anchored in recent years, contributing to a muted response of inflation to oil price shocks.  But the anchoring of expectations cannot be taken as given; indeed, the type of empirical exercises I have outlined reveal a larger effect of the price of oil on inflation prior to the last two decades, a period in which inflation expectations were not as well anchored as they are today.

It is important to note, however, that futures prices do not generally reflect an expectation that oil prices will continue rising at their recent rapid rate. In the past, higher oil prices have spurred conservation efforts and contributed to slower economic growth – both reducing energy demand. Higher oil prices also encouraged new technological improvements, and exploration and production from higher-cost sources – increasing supply. In other words, economists expect that the laws of supply and demand will ultimately limit price increases – even in the face of relatively rapid economic growth in emerging markets. That said, it seems to be taking quite a long time to date for long-run supply and demand influences to rein in oil price increases. You might say the short run is getting longer every day. 

Empirical work on inflation, including much of the classic work on Phillips curves, has generally treated changes in commodity prices as an exogenous influence on the inflation process, driven by market-specific factors such as weather conditions or geopolitical developments.  By contrast, some analysts emphasize the endogeneity of commodity prices to broad macroeconomic and monetary developments such as expected growth, expected inflation, interest rates, and currency movements.  Of course, in reality, commodity prices are influenced by both market-specific and aggregate factors...

I have only mentioned a few of the issues raised by commodity price behavior for inflation and monetary policy.  Here are a few other questions that researchers could usefully address:  First, how should monetary policy deal with increases in commodity prices that are not only large but potentially persistent?  Second, does the link between global growth and commodity prices imply a role for global slack, along with domestic slack, in the Phillips curve?  Finally, what information about the broader economy is contained in commodity prices?  For example, what signal should we take from recent changes in commodity prices about the strength of global demand or about expectations of future growth and inflation?

Policymakers and other analysts have often relied on quotes from commodity futures markets to derive forecasts of the prices of key commodities.  However, as you know, futures markets quotes have underpredicted commodity price increases in recent years, leading to corresponding underpredictions of overall inflation.  The poor recent record of commodity futures markets in forecasting the course of prices raises the question of whether policymakers should continue to use this source of information and, if so, how.

Despite this recent record, I do not think it is reasonable, when forecasting commodity prices, to ignore the substantial amounts of information about supply and demand conditions that are aggregated by futures markets...

To be sure, commodity prices did rise as interest rates fell. However, for many commodities, inventories have fallen to all-time lows, a development that casts doubt on the premise that speculative demand boosted by low interest rates has pushed prices above levels that would be consistent with the fundamentals of supply and demand. As interest rates in the United States fell relative to those abroad, the dollar declined, which could have boosted the prices of commodities commonly priced in dollars by reducing their cost in terms of other currencies, hence raising the amount demanded by people using those currencies. But the prices of commodities have risen substantially in terms of all currencies, not just the dollar. In sum, lower interest rates and the reduced foreign exchange value of the dollar may have played a role in the rise in the prices of oil and other commodities, but it probably has been a small one.

The rise in commodity prices presents particular challenges for monetary policy because such increases both add to near-term inflationary pressures and damp demand. A tendency for increases in commodity prices to become a factor in ongoing pricing and wage-setting more generally would be a worrisome development that would over time tend to undermine economic welfare.

In the international sector, continued strong growth in the rest of the world will slow the growth of the trade deficit.  An expanding world economy is expected by many economists to generate increasing demand for U.S. exports.  Such growth, however, is also likely to further increase global demand for natural resources.  This implies that prices for commodities such as oil may remain at elevated levels for an extended period of time.

My sense is that commodity price pressures have substantially disappeared. You heard a lot, for example, about steel price pressures a while back and I don't think that is so much of an issue anymore...I think those prices have stopped rising on the whole.

[T]he direct effects of commodity price inflation on consumer inflation are empirically minuscule, both because raw materials costs are a small portion of total cost and because part of any increase in the cost of materials tends to be absorbed in the margins of final goods producers and distributors. Accelerations in commodity prices comparable to or larger than the most recent one occurred following the 1981-82 and 1990-91 recessions, as well as in 1986-87 and 1999, with no noticeable impact on inflation at the consumer level. A reasonable rule of thumb is that a permanent 10 percent increase in raw materials prices will lead to perhaps a 0.7 percent increase in the price of intermediate goods and to less than a 0.1 percent increase in consumer prices. Thus the recent acceleration in commodity prices, even if it were to persist (and futures prices suggest that it will not), would likely add only a tenth or two to the core inflation rate. In short, rising commodity prices are a better signal of strengthening economic activity than of inflation at the consumer level.