By Mike Bryan, Brent Meyer, and Nicholas Parker
We've been thinking a lot about commodity prices lately. In case you haven't noticed, they've been falling. And with inflation already tracking well under the Federal Open Market Committee's (FOMC) longer-term objective of 2%, it's reasonable to wonder whether the modest downward tilt in commodity prices is likely to put even more, presumably unwanted, disinflation into the pipeline.
We take some comfort from research by Chicago Fed President Charles Evans and coauthor Jonas Fisher, vice president and macroeconomist, also of the Chicago Fed. They conducted a statistical analysis of commodity prices and core inflation and found no meaningful relationship between the two in the post-Volcker era of the Fed. According to the authors:
[I]f commodity and energy prices were to lead to a general expectation of a broader increase in inflation, more substantial policy rate increases would be justified. But assuming there is a generally high degree of central-bank credibility, there is no reason for such expectations to develop -- in fact, in the post-Volcker period, there have been no signs that they typically do.
We took this bit of good news to our boss here at the Atlanta Fed, Dennis Lockhart, who hit us with a question we wish we had thought to ask. To paraphrase: Is the response of inflation different for commodity price increases compared to commodity price decreases? The idea here is that, for a time at least, firms will pass commodity price increases on to their customers but simply enjoy higher margins when commodity prices decline.
So we reached out to our business inflation expectations (BIE) survey panel and put the question to them. Full results of July's business inflation expectations survey will be posted on our website tomorrow (July 17). Of the 209 firms who responded to the survey in July, half were asked how they would likely respond to an unexpected 10% increase in the costs of raw materials, and the other half were asked how they would likely respond to an unexpected 10% decrease. What we learned was that the boss was on to something.
Of course, what a firm thinks it will do and what the marketplace will allow are not necessarily the same. But this got us thinking back to the earlier work at the Chicago Fed. Does this sort of "asymmetric" response to commodity prices appear in the data?
As in Evans and Fisher, focusing in on just the post-Volcker era (from 1982 forward), we found that the influence of positive commodity price increases on core inflation was significantly diminished (although it appears to be just a little stronger than what they had reported). However, the influence of commodity price decreases on core inflation remained the same -- nada.
For many of you, this result probably doesn't strike you as pathbreaking. There are many macroeconomic models where prices are "sticky" going down but pretty flexible on the way up. But if the question is whether we think the recent slide in commodity prices is likely to put added downward pressure on core inflation, we're likely to echo Evans and Fisher with a bit more emphasis: The decline in commodity prices isn't likely to have an influence on core inflation unless it leads to a general expectation of a broader disinflation. And there is no evidence in the data that suggests this is likely -- post-Volcker era or not.