The Effect of Commodity Prices on Inflation

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The effect of commodity prices on inflation is considered in the following literature. Commodity prices are thought to be leading indicators of inflation for two reasons. The first is that in general commodity prices respond to economic shocks quicker than macroeconomic variables. The second is that commodity prices reflect global shocks such as floods, which may lead to agricultural price rises and therefore, leads to higher consumer prices, (Furlong, 1996).
2.1 Oil Prices on Inflation

Fluctuations in oil prices are usually found to have an impact on macroeconomic variables. A concern is the effect oil prices have on inflation. A number of studies have found a cause and effect relationship between oil prices and inflation. It is thought that a rise in oil prices tends to lead to a rise in inflation for many countries, due to its need as an input process for a variety of products. (Hooker, 2002) empirically analysed the effects of oil prices on inflation from 1962 to 2000. His study found that up to the period of 1981 a significant change in oil prices contributed to inflation in the US. However, after 1981 statistical evidence showed that this was no longer the case. (Cologni & Manera, 2008) explained that the failure of the 1986 oil price collapse to stimulate economic activity meant that many economists believed that the relationship between oil price changes and economic activity no longer holds.
As a result, (Cologni & Manera, 2008) examined the relationship between oil prices and inflation post 1980 and analysed not just the US but members of the G7 to see whether the relationship had returned. They looked at the period between 1980-2004 and disproved (Hooker, 2002) by finding that oil prices have a significant influence ...

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...un relationship between interest rates and inflation for the Eurozone and US. Their results showed a casual long-run relationship between interest rates and inflation and that nominal interest rates contained information about future inflation.
In this study, such variables have been used as control variables and therefore the choice and the theory behind these variables are provided in the data and methodology section.
This study is different to previous literature as it considers all three commodities in a single framework. This allows for the analysis of all three commodities for different countries and allows for one to see which commodity has the biggest influence on inflation for the countries considered. The literature has also shown the importance of including other indicators of inflation when analysing commodity prices and so they will also be included.

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