World Bank Document

Box 3.1
Primary commodity prices, business cycles, and the real exchange rate of the dollar
Commodity prices have always been strongly influenceu tries such as Brazil: Brazil is a net primary commodity
by the economic cycle in industrial countries. Some exporter, but a large share of its imports come from the
econometric evidence suggests that a one percentage United States. For countries like Brazil many things went
point rise in the OECD unemployment rate leads to a 15 wrong simultaneously in 1981-82. Interest rates rose
percent fall in real commodity prices. However, this rela- while the recession depressed commodity prices; the
tionship seems to have changed in the present cyclical dollar appreciation also depressed primary commodity
upswing. In real terms, commodity prices fell 44 percent prices further and raised the cost of imports. Net pribetween
1979 and 1982-real in this case meaning the mary commodity importers such as Korea at least got the
nominal prices deflated by the U.S. GDP deflator-but, benefit of cheaper commodity imports. Box figure 3.1A
after rising in 1983, prices have fallen steadily since mid- demonstrates this by plotting the real interest rate in
1984, despite the economic recovery. terms of export prices-LIBOR minus the rise in dollar
Part of the explanation for the sharp fall in the period export prices-for Korea and Brazil.
1980-82 and for the unusual decline since mid-1984 lies
in the large real appreciation of the dollar since 1980. A Box figure 3.1A Real LIBOR for Brazil and
rise in the real value of the dollar with respect to other the Republic of Korea, 1965-84
industrial countries makes American goods more expensive
in terms of goods from those countries. For given Percent
commodity prices, demand for primary commodities in 20
the United States will rise since their cost in terms of
U.S. goods has fallen. This will divert some commodity
Korea
exports from the other industrial countries to the United _
States and also bring forth some extra supply. The net
effect will be a fall in commodity prices in terms of U.S. 0 J
goods and a rise in terms of goods from other industrial
countries. If the United States has a larger share in world \
trade than its commodity imports have in total OECD -10
commodity imports, commodity prices will fall in terms
Brazil
of traded goods in general after an appreciation of the -20 '
dollar. Empirical analysis shows that a 10 percent real
appreciation of the dollar brings real commodity prices in 1965 1970 1975 1980 1984
terms of U.S. goods down by 6 percent.
Source: IMF International Financial Statistics.
This relationship has obvious implications for counmid-1970s,
although easy to explain with hind- had deficits, industrial countries as a whole aversight,
were unexpected at the time. First, the aged surpluses of $12 billion a year during 1975-78.
OPEC surpluses were "recycled" with surprising In contrast, oil-importing developing countries
ease, largely because of the growth of the Eurodol- went into substantial deficit in 1974 and 1975. Defilar
market (see Chapter 6); the second surprise was cits remained high in 1976-78, compared with the
the pattern of current account deficits that level in 1973, although they declined somewhat as
emerged. a proportion of GNP in those countries.
Industrial countries-the main oil importers- OPEC surpluses were thus recycled largely to
were expected to run deficits to offset the OPEC the developing countries, not to industrial counsurpluses,
with developing countries playing a tries. This was made possible by a major change in
minor role in recycling. Most observers judged the structure of financial flows between industrial
that the financial mechanisms needed for recycling and developing countries, as commercial banks
surpluses to developing countries simply did not became much more prominent than they had
exist. Table 3.1 shows how things in fact devel- been. Although official loans and grants from
oped. The seven largest industrial countries industrial countries increased considerably in
quickly reverted to pre-1973 patterns in their exter- 1974-75, the biggest change was the growth of
nal accounts. They had a $2.8 billion deficit in 1974, commercial bank lending to developing countries.
then swung back into surpluses averaging $20 bil- This established international capital markets as a
lion a year in 1975-78 compared with $9.7 billion in major channel for transmitting the effects of mac-
1973. Although some smaller industrial countries roeconomic policies in industrial countries to
32