Taylor rule and commodity prices

Hat tip to FT Alphaville on discussing the link between commodity prices and the Taylor rule for monetary policy. The work presented from Telluride asset Management looks at the cumulative difference from the Taylor rule for monetary policy and the cumulative log change in certain commodity prices. The result is a strong link between monetary easing and commodity prices.

The link between negative or low real rates of interest and commodity prices has been well documented but this work places a nice twist in the subject through looking explicitly on the ease or tightness of monetary policy. By this broad measure we should still see continued increases in prices as long as the excess liquidity of the Fed is present.

The Taylor Rule can be looked at two ways. First, historically we can see that the Fed may have been too aggressive with easing during the post tech boom. The Fed also began easing very quickly in early 2008. Second, when the Fed too rates down to 25 basis points, the Taylor Rule suggested that rates should actually be negative. This is the zero rate problem which required the need for quantitative easing, "unconventional" policy, or a large asset purchase program.

The current low environment makes it more difficult to judge policy, but the Taylor Rule is suggesting less easing is necessary and that there is little reason to raise rates this year.