Macroeconomic Performance during Commodity Price Booms and Busts

NBER digest: Fluctuations in commodity prices often are associated with macroeconomic volatility and thus pose significant challenges for policymakers in commodity-producing nations. In Macroeconomic Performance During Commodity Price Booms and Busts (NBER Working Paper No. 18569), authors Luis Felipe Céspedes and Andrés Velasco investigate the macroeconomic response of a group of commodity-producing nations in episodes of large commodity price booms and busts. Because that response depends on the structural characteristics of the economy and the policy framework that is in place, the analysis focuses on the response of economic activity and the real exchange rate to commodity price shocks, notably controlling for the role played by financial market depth and the exchange rate regime.

Using two different indexes of commodity prices, the authors identify more than 80 commodity price booms and busts in over 30 countries between 1960 and 2008. They estimate that a 60 percent increase in the commodity price index increases output by close to 1 percent with respect to trend output. More flexible exchange rate regimes are associated with smaller responses of output during commodity price episodes. Indeed, flexible exchange rate regimes tend to better insulate the economy from price shocks as the nominal exchange rate adjusts immediately to the real shock. The impact of those shocks on output tends to be larger for economies with less developed financial markets.

An increase of 60 percent in the price index is also associated with an increase in the investment rate of around 3.5 percentage points. The investment increase is larger for economies with higher financial depth. Furthermore, for the episodes before the 2000s, the presence of more developed financial markets appears to have mitigated the impact of commodity price shocks on credit.

The authors also find that the rate of international reserve accumulation tends to reduce the appreciation of the real exchange rate in episodes of commodity price booms and busts. An accumulation of 10 percent of GDP in international reserves tends to be associated with depreciation in the real exchange rate of 5 percent. The authors argue that this result, combined with the fact that more flexible exchange rate regimes tend to be associated with more stable output dynamics, suggests that a mix of a more flexible exchange rate regime with exchange rate interventions might help to reduce macroeconomic volatility. Their analysis also suggests that the impact of commodity price shocks on the real exchange rate is reduced when the political system is more stable.

--Claire Brunel