Booms and busts in commodity markets are a particularly important part of the global economy. They affect inflation and consumer spending, determine investment and welfare in producing nations. They also influence growth enhancing institutions and may even lead to civil unrest. Understanding which shocks drive these low-frequency price movements and how long they persist is important in formulating environmental and resource policies, for the conduct of macroeconomic policy, and, most importantly, for investment decisions involving extractive and agricultural sectors of the economy.
Commodity prices are driven by shocks on the supply and demand sides. For example, a commodity supply shock is an unexpected decline in crop yield due to adverse weather, which shifts the supply curve inward and increases prices. An aggregate commodity demand shock changes the demand for all commodities at the same time. For example, China’s rapid industrialization led to stronger-than-expected increases in the
demand for a broad variety of commodities such as copper, oil and wheat over the past decade.