Expectations and Commodity Price Dynamics: The Overshooting Model

Abstract Monetary policy has important effects on agricultural commodity prices because, though they are flexible, other goods prices are sticky. This paper formalizes the argument by applying the Dornbusch overshooting model. A decline in the nominal money supply is a decline in the real money supply in the short run. It raises the real interest rate, which depresses real commodity prices. They overshoot their new equilibrium in order to generate an expectation of future appreciation sufficient to offset the higher interest rate. These real effects (which vanish in the long run) also result from a decline in the money growth rate.