How to Cope with Volatile Commodity Export Prices: Four Proposals

Abstract

Countries that specialize in commodities have in recent years been hit by high volatility in world prices for their exports. This paper suggests four ways that commodity-exporters can make themselves less vulnerable.

(1) Option contracts can be used to hedge against short-term declines in the commodity price without giving up the upside, as Mexico has shown.

(2) Commodity-linked bonds can hedge longer-term risk, and often have a natural ultimate counter-party in multinational corporations that depend on the commodity as an input.

(3) The well-documented pro-cyclicality of fiscal policy among commodity exporters can be reduced by insulating official forecasters against an optimism bias, as Chile has shown.

(4) Monetary policy can be made automatically more counter-cyclical, judged by the criterion of currency appreciation in reaction to positive terms-of-trade shocks, under either of two regimes: peggers can add the export commodity to a currency basket (CCB, for “Currency-plus-Commodity Basket”) and others can target Nominal Income instead of the CPI.