495 Commodity Price Paper – Final Commodity Prices and the Real Interest Rate

For this paper, I have studied the relationship between real commodity prices and the real interest rate. My initial research into the topic led me to the paper “The Effect of Monetary Policy on Real Commodity Prices ” by Jeffrey Frankel. He argues that the real price of a commodity (relative to its long-run equilibrium) is inversely proportional to the real interest rate. This is because as the interest rate rises, the demand for storable commodities is reduced, or the supply is increased. Frankel provides three reasons for this. There is more of an incentive for extraction, there is less desire to carry inventories, and speculators shift out of commodity contracts and into treasury bills (Frankel, 2006). Basically, when interest rates rise there is more to gain by selling what you have today and putting your money in the bank, rather than keeping it invested in storable commodities. I investigated how well this relationship holds for individual food commodities. Specifically, since the relationship exists because of how inventories change, I wanted to see whether the relationship is stronger for more storable commodities (i.e. commodities which can be stored for longer periods). The idea is that the more storable a commodity is, there are more options for when to sell, and thus interest rates will have a stronger effect on the price. If the commodity is not as storable (for example, the food will rot), there wil