Standard 7 - Resource markets and financial markets determine wages, interest rates and commodity prices.

Benchmark - 9.2.4.7.1 - Explain the role of productivity, human capital, unions, demographics and government policies in determining wage rates and income in labor markets.

Effect of Interest Rates on Commodities

If the price of gas is unusually high and a carton of eggs costs more than it did a year ago, low interest rates might be to blame. When the Federal Reserve adjusts interest rates in hopes of stimulating the economy, commodity prices react as well. The reasons for the change in commodity prices have to do with confidence in the dollar, a weakened currency and increased overseas demand for certain commodities.

Interest Rates

• Interest rates control the amount of money in circulation. When the Federal Reserve wants to reduce the unemployment rate and stimulate economic activity, a way to try to achieve this is lowering nominal interest rates. For instance, the Federal Reserve set nominal interest rates near zero percent to induce banks to lend money after the mortgage meltdown of 2008. When interest rates decrease, businesses become more willing to take out loans. However, a side effect of lowering interest rates is increasing the money supply. When the money supply expands, the prices of goods and services increase as a result of inflation.

Dollar Value

• If interest rates drop and the money supply expands, the dollar becomes worth less. This depreciation in the dollar creates rising prices for basic consumer commodities. The increase in price is a result of the stimulated demand for goods and services: Consumers have more disposable income when more money is in circulation. Additionally, low interest rates coupled with a weakened dollar encourage people to spend money rather than save it.

Considerations

• Governments view commodities as a way to safeguard the value of their savings. While many central banks buy dollars to protect the value of their country's currency, they may choose to sell dollars and buy commodities such as gold and silver if they have concerns over the dollar's stability. Ronald McKinnon explains in a January 2011 "Wall Street Journal" article how inflation and a weak dollar caused commodity prices to rise in 2010, 2003 and 1971. Each of these times, countries purchased more commodities instead of dollars. Increased demand from abroad is another reason why commodity prices rise.

Read more: Effect of Interest Rates on Commodities | eHow.com http://www.ehow.com/info_7832534_effect-interest-rates-commodities.html#ixzz23NjBiY2O

1. How does the changing interest rates effect commodity prices?

2.  How can world events and market speculation affect commodity and other prices?

3.  Describe a scenario where unrest in the oil-producing nations raises the price of Oil which raises the cost of energy of producing many goods and services?