The Commodity–Consumer Price Connection: Fact or Fable?

nterest in commodity prices as indicators of consumer price inflation has ebbed and flowed with the rise and fall in commodity prices themselves. True to form, as commodity prices have surged in the last two years (Chart 1), interest in their predictive power has returned. Inflation hawks point to an outpouring of studies in the late 1980s showing a strong empirical connection between commodity prices and subsequent consumer inflation. Indeed, the concern over commodities has grown to the point where even two previously obscure commodity indexes—the National Association of Purchasing Managers price index (NAPM) and the Federal Reserve Bank of Philadelphia’s prices paid index (PHIL)—have begun to capture considerable attention among economists and market analysts. Is this renewed attention warranted? In this article, we argue that none of the channels through which commodity prices signal more generalized inflation are operating as well as they did in the past: commodities have become less important as an input to production, some of the inflation signals from commodity prices may be sterilized by offsetting monetary policy, and commodities have become less popular as an inflation hedge. We also present evidence that the recent commodity movements are a reaction to swings in dollar exchange rates rather than a signal of generalized inflation pressures. Our empirical results underscore the diminished signaling power of commodities in the last eight years. Drawing on data for the 1970-94 period, we examine five major U.S. commodity indexes and three subgroups of commodities—gold, oil, and food. We use vector autoregression models (VARs) to test whether commodity prices are useful in predicting subsequent movements in both the finished goods producer price index (PPI) and the core— that is, nonfood and nonenergy—consumer price index (CPI). These VAR methods allow us to isolate the predictive power of commodity prices while controlling for other determinants of inflation. We find that: • Contrary to conventional theory, there is no long-run link between the level of commodity prices and the I The views expressed in this article are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System.