Commodity Prices and Interest Rates: the Euro Zone

Commodity prices rose jointly to record levels during the past decade and it has been argued that this development is due to macroeconomic factors. Frankel has presented a theory which explains commodity prices to be negatively correlated to real interest rates. This paper empirically investigates if the real interest rate negatively affects commodity prices and if they exhibit overshooting characteristics, using the Euro real interest rate as a proxy for world interest rate. This is analysed by means of a VAR model, by which the output is used to specify impulse responses and variance decompositions. The obtained result is that the Euro real interest rate negatively affects commodity prices over the medium run. Moreover, the effect on commodity prices of a Euro real interest rate change is bigger than the like of the United States. Therefore the ECB must take into account the endogeneity of commodity prices when performing an effective monetary policy with the aim of keeping inflation level stable