The summary states:
This paper interprets recent events and thinking in commodity markets and evaluates what these mean for New Zealand and monetary policy.
We conclude demand is underpinning commodity prices, creating a structural shift in the terms of trade of commodity exporters like New Zealand. Against this backdrop, idiosyncratic events such as weather-related crop failures and changes to government policies have pushed prices to historical highs. Supply responses will be relatively slow, implying prices are likely to stay high over the short to medium term, if a little lower than current levels.
New Zealand’s agricultural export prices are likely to remain at elevated levels for some time. Demand is underpinned by urbanisation and wealth growth in developing countries, especially China. However, there is potential for near term price falls as supply becomes less weather disrupted.
The appropriate monetary policy response will focus on the inflationary pressure that arises, not the terms of trade shift in itself. Higher terms of trade will contribute to appreciation of the exchange rate, facilitating the necessary adjustment in the real exchange rate via the nominal exchange rate rather than via rising inflation.
Medium term inflation remains the Bank’s focus. The Bank needs to be cautious that a terms of trade increase does not lead to increases in inflation expectations. For example, households and firms might use the income boost from higher commodity prices and exchange rates to bring forward consumption and investment, or increase borrowing. Consequent pressure on resources within New Zealand would lead to more inflationary pressure and monetary policy would counteract any rise in inflation expectations.
However, large uncertainties surround the outlook and underlying drivers for prices. One thing we do know is that the outlook will remain uncertain. History shows it is fiendishly difficult to predict the future path of commodity prices.
The last paragraph is most interesting.