1995 Reports

Consequences of Discretion in the Formation of Commodities Policy

McLaren, John

We present a simple model of endogenous commodity policy, in which (i) government action
is affected by the size of private inventories, and (ii) private inventories are determined by
speculators trying to forecast government action. The interaction between these two forces is
rich, giving rise to the possibility of bubbles and extrinsic volatility in a market which in the
absence of government would have had a unique, well-behaved, equilibrium. In addition,
under some conditions a government that wishes to support the price but is unable to commit
to future action may be impotent; and a government that does not want to support the price
may be "trapped" into doing so anyway by the activity of speculators.