The Importance of Commodity-Price Shocks

Abstract

Unexpected movements in world prices are believed to significantly affect domestic economic conditions in emerging market and developing economies (EMDEs). Previous studies have examined the role of world price fluctuations in EMDEs from an overall terms of trade perspective. In this paper, I depart from these studies by analyzing the importance of commodity import and export price shocks as a source of business cycles in EMDEs. I argue that for these countries, commodity price indices are better at capturing exogenous world price shocks than the overall terms of trade. Given the conflicting results between theoretical and empirical models in previous similar studies, I approach my analysis from both perspectives and test whether empirical and theoretical predictions can be reconciled. Specifically, I first use a Structural Vector Autoregressive (SVAR) model on 28 EMDEs to compute the shares of the variances of the trade balance, output, consumption, investment, and the real exchange rate attributable to commodity import and export price shocks. I find that empirically, these shocks explain 26-30% of business-cycle fluctuations in the selected countries. I then develop a 5-sector RBC model in which I explicitly introduce commodity import and export prices. Using this model, I compute the same variance shares as in the SVAR model. The RBC model predicts that on average, commodity import and export price shocks can only explain 2-3% of business-cycle fluctuations in the selected countries. In addition, a country-by-country comparison of the variance shares predicted by the SVAR and RBC models suggests that these models are also disconnected at the country level when it comes to measuring the importance of commodity-price shocks in EMDEs.