Commodity Export Prices and the Real Exchange Rate in Developing Countries: Coffee in Colombia

In this paper a model that analyzes the interaction between changes in commodity export prices, money creation, inflation, and the real exchange rate in a developing country is developed. The model is then tested using data for Colombia. A number of experts have argued that the fluctuations of Colombia's real exchange rate have been mainly determined by world coffee price changes, with more observers emphasizing the consequences of coffee price changes on money creation and inflation. The results obtained indicate that coffee price changes have indeed been closely related to money creation and inflation. Also, coffee price changes have been negatively related to the rate of devaluation of the crawling peg. These results indicate that in Colombia, the real appreciation resulting from coffee price increases has been accommodated, partially by money creation and partially by an adjustment in the nominal exchange rate.