Are Shocks Transitory or Permanent? An Inquiry into Agricultural Commodity Prices

Abstract

This paper contributes to the contentious topic of whether shocks to agricultural commodity prices are permanent or transitory. This is an important issue with regards to forecasting, economic modelling of agricultural prices and risk management. Past studies have not accounted for important characteristics of agricultural prices that matter when testing whether shocks to prices are permanent or transitory. These include the presence or absence of a deterministic trend, the possible break in the trend, non-stationary volatility, and the problem of the initial deviation of commodity prices from their long-run mean or trend. We conduct a comprehensive test that incorporates all these characteristics known to plague agricultural commodity prices. Though the conclusion is mixed, the balance is in favour of agricultural price shocks being permanent in nature. This result departs from the general view that in theory, agricultural prices should be stationary, suggesting that the controversy of whether shocks to agricultural prices are temporary or permanent is not yet over.