Dynamic interactions between commodity prices and Australian macroeconomic variables

Abstract

Price swings of commodities affect the economies of commodity exporting nations worldwide and these fluctuations are a major concern for Australian policy makers. Australia is one of the major commodity exporting countries in the global market; therefore, the main focus of this thesis was to shed light on the influence of various fundamental macroeconomic variables on Australian commodity prices. First, emphasis was placed on what magnitude changes in real interest rates and fluctuations of the real exchange rate account for volatility in commodity prices and whether commodity prices tend to show overshooting phenomena (J. Frankel, 1986; J. Frankel, 2006) in reaction to interest rate changes. The possible contribution of global real economic activity to Australian commodities prices was then assessed, which can lead to both higher interest rates and volatile commodity prices (Akram, 2009; Svensson, 2008) within Australia. Similarly, the current slowdown in world economic growth after several years of high growth might clarify the sharp drop in real interest rates and commodity prices. In addition, the present study explored whether Australian resources stock prices had significant predictive ability for the future global commodity price index as suggested by Rossi (2012). Johansen's (1988, 1991) cointegration technique was utilised to attain the above research objectives and to examine the long-run relationship of the considered variables. This thesis utilised seasonally adjusted monthly time series for real interest rate, real exchange rate, industrial production and resources stock price from January 2000 to December 2015 after considering an appropriate structural break. The study found significant long-run relationships among the variables; therefore, the vector error correction model was applied to judge the short-run dynamic relationship among variables. Then, the forecast ability of all variables was assessed by employing vector error correction Granger causality or block exogeneity tests. Single equation models do not allow the examination of dynamic relations between commodity prices and other macroeconomic variables over different time horizons (Akram, 2009); therefore, the study applied the impulse response technique as well as forecast error variance decomposition to assess the comparative influences of diverse shocks to the variations in key variables of the proposed commodity price model. The research found significant negative relationships between real interest rates and commodity prices. However, the impulse response results did not show any immediate responses of commodity prices because of an impulse in the real interest rate. This showed a significant negative response of commodity prices after six months of the initial shock and the importance of interest rate information to predict the commodity prices in the long run. In two years' time, approximately one third of the commodity price changes will be explained by the shocks in real interest rate. The shocks from opposite directions showed a significant negative response for real interest rate after having shocks from Australian commodity prices in the medium term. The results of the present study also suggested an immediate fall in Australian commodity prices and thereafter increases at a higher rate significantly in response to the real exchange rate shock, consistent with Frankel's (1986) overshooting model of commodity prices. This finding raised the question as to whether real exchange rate shocks are a significant factor of Australian macroeconomic instability as commodity export plays an important role in its economy. Results of the present study revealed the response to this query as being in the negative, especially in the long run. The interaction of these two variables from opposite directions showed interesting results. Separate commodity-related drivers of exchange rates results showed that Australian real exchange rate movements were not purely random. Vector error correction-based Granger causality tests indicated a strong support of causality from commodity prices to real exchange rate in the short run. The impulse response results showed the most noteworthy results. The shocks from Australian commodity prices showed immediate significant depreciation in real exchange rates and the index remained depreciated significantly in all horizons, which shows the complete opposite results to many studies (Connolly & Orsmond, 2011; Minifie, Cherastidtham, Mullerworth, & Savage, 2013; Plumb, Kent, & Bishop, 2013; Sheehan & Gregory, 2013). However, this finding is consistent with the theoretical explanation provided by Dumrongrittikul (2012) to explain the puzzle of the Chinese real exchange rate, which is supported by the theoretical explanation of S. Edwards' (1989) real exchange rate model. The results of the present study also showed that the shock to industrial production had a negative effect on Australian commodity prices and the effect remained significant during all time horizons. It also showed that the commodity price fluctuation had predictive ability of the Australian resources stock prices. After considering these above findings, several policy recommendations for relevant Australian authorities are suggested and limitations are discussed including the pathway for future research.

Date of Award	2017
Original language	English