Should Commodity Exporters Peg to the Export Price?

• Author: Stefan Hohberger,Bernhard Herz,Lukas Vogel
• Date: 01 August 2015
• Published date: 01 August 2015
• DOI: http://doi.org/10.1111/rode.12172

Should Commodity Exporters Peg to the

Export Price?

Lukas Vogel, Stefan Hohberger, and Bernhard Herz*

Abstract

To account for the specific situation of commodity exporters, pegging to export prices (PEP) has been pro-

posed elsewhere as an alternative to other conventional monetary regimes such as an exchange rate peg or

inflation targeting. PEP is supposed to deliver automatic accommodation to terms-of-trade shocks, while

retaining the credibility gain from a nominal anchor. This paper analyzes the PEP proposal in a dynamic

general-equilibrium model and compares it with a standard Taylor rule, consumer price index (CPI)-level

targeting and a nominal exchange rate peg. Judged by the degree of output stabilization, PEP performs

very similar to CPI targeting for export demand as well as domestic demand shocks and underperforms in

the case of shocks to the export price. The results suggest that PEP is not superior to conventional CPI tar-

geting from a macroeconomic stabilization perspective.

1. Introduction

Choosing an appropriate monetary regime is one of the most difficult macroeconomic

decisions for a government as there is no strategy that is optimal under all circum-

stances. Governments have to balance the benefits of monetary independence with

the positive credibility effects of tying their hands and to forego policy flexibility. If

they decide to follow an explicit monetary rule there is a wide choice of nominal

targets such as a conventional exchange rate peg or inflation targeting. The choice of

the monetary regime depends in the end on the specific structure of an economy, e.g.

the degree of openness, the importance of nominal and real rigidities, and the likeli-

hood of (a)symmetric real and nominal shocks.

Specific situations arise for developing countries, in particular for countries that are

specialized in the export of commodities. Given that many developing countries have

experienced increasing terms-of-trade volatility, Frankel has initiated the discussion

of alternative nominal anchors for these countries in a series of papers (Frankel, 2003,

2005, 2008). He points out that conventional inflation (consumer price index, CPI)

targeting and exchange rate pegs might be inappropriate in the case of high export

price volatility. Frankel argues that, e.g. in the case of falling commodity prices on

world markets, the domestic currency of commodity exporters should depreciate to

accommodate for the deterioration in the terms of trade. Neither a CPI target nor a

nominal exchange rate peg would provide the necessary loosening of monetary policy

(Frankel, 2008, 2011, 2014).

Against this background, Frankel argues that small commodity exporters should

protect themselves from volatility in the export sector and stabilize export prices and

* Vogel: European Commission, DG Economic and Financial Affairs, CHAR 14/233, 1049 Brussels,

Belgium. Tel: +32 229-99557; E-mail: lukas.vogel@ec.europa.eu. Hohberger, Herz: University of Bayreuth,

Universitaetsstraße 30, 95447 Bayreuth, Germany. The authors would like to thank two anonymous ref-

erees as well as participants of the International Conference “Exchange Rates, Monetary Policy and Finan-

cial Stability in Emerging Markets and Developing Countries” (Leipzig, 2014) for very helpful comments.

The views in this paper are personal and should not be attributed to the European Commission.

Review of Development Economics, 19(3), 486–501, 2015

DOI:10.1111/rode.12172

© 2015 John Wiley & Sons Ltd

revenues in domestic currency terms. He proposes an alternative anchor for monetary

policy, called pegging the export price (PEP) or in a more general version pegging the

export price index (PEPI) (Frankel, 2003, 2005, 2008). While PEP aims at stabilizing

economic conditions by smoothing the domestic currency price of a single (dominant)

export commodity, PEPI targets a broad index of export prices to avoid competitive-

ness losses of all other exports if the price of the targeted commodity in the world

rises (Frankel, 2003, 2005). The proposal of PEP or PEPI focuses on commodity-rich

exporters for which exports prices tend to be more volatile than for countries with a

more differentiated export structure.

To illustrate his point, Frankel (2003, 2005, 2008) simulates, assuming constant

volumes, export and trade balance paths of emerging economies had PEP been

adopted in the past. Frankel (2011) compares the paths of export prices for some

Latin American and Caribbean countries under alternative monetary regimes, includ-

ing CPI and PEP targeting as well as exchange rate pegs to the US dollar, the euro

and the special drawing rights (SDR). His calculations suggest that PEP and PEPI

deliver more stability in the real prices of traded goods in the case of terms-of-trade

shocks since monetary policy would tighten enough to appreciate the domestic cur-

rencies when export (commodity) prices rise, which would not be the case under CPI

targeting. These hypothetical paths do, however, take trade volumes as given and

neglect general-equilibrium effects, i.e. feedback from monetary policy on prices,

output and exchange rates, or assume a separation of domestic and foreign capital

markets so that policy makers can manipulate the nominal exchange rate without

changing the domestic policy stance.

To the best of our knowledge, this paper is the first to assess the pegging to export

price strategy in comparison with alternative nominal anchors (CPI, exchange rate

(XR)) in a dynamic general-equilibrium model. The simulation results suggest that

PEP performs very similarly to CPI targeting with respect to stabilizing domestic eco-

nomic activity for export demand shocks as well as domestic demand shocks and

underperforms by destabilizing domestic activity in the case of exogenous export

(world market) price shocks. These results are robust throughout a number of sensi-

tivity checks.

2. Stylized Facts

This section provides some stylized facts about export price volatility and correlations

between export prices and volumes, which is an indicator for the type of shocks

hitting exporting countries. To highlight the differences between developed econo-

mies, with focus on manufactured exports, and classical commodity-exporting emerg-

ing economies, we choose the US as benchmark and Russia, Chile and South Africa

as examples of commodity exporters, namely exporters of crude oil, copper and gold,

respectively.

Figure 1 depicts quarter-on-quarter percentage changes in the export price defla-

tors in domestic currency (panel a). It shows that that export price volatility tends to

be significantly higher in commodity-exporting countries. While export prices in the

USA have followed a relatively stable path, Russia, Chile and South Africa have

experienced frequent changes in the export price index within a band of +/− 10%.

Panel b in Figure 1 shows the ratio of the export price deflator to the gross domestic

product (GDP) deflator to gain some insight into whether the behavior of export

prices has differed from domestic price dynamics. The two price indices are normal-

ized to 1 in 2005. A constant ratio of 1 would, hence, imply that export prices and the

PEGGING TO EXPORT PRICES 487

© 2015 John Wiley & Sons Ltd