Commodity Booms and Busts in Emerging Economies

Abstract

Emerging economies, particularly those dependent on commodity exports, are prone to highly disruptive economic cycles. This paper proposes a small open economy model for a net commodity exporter to quantitatively study the triggers of these cycles. The economy consists of two sectors, one of which produces commodities with prices subject to exogenous international fluctuations. These fluctuations affect both the competitiveness of the economy and its borrowing terms, as higher commodity prices are associated with lower spreads between the country's borrowing rate and world interest rates. Both effects jointly result in strongly positive effects of commodity price increases on GDP, consumption and investment, and a negative effect on the total trade balance. Furthermore, they generate excess volatility of consumption over output and a large volatility of investment. The model structure nests various candidate sources of shocks proposed in previous work on emerging economy business cycles. Estimating the model on Argentine data, we find that the contribution of commodity price shocks to fluctuations in post-1950 output growth is in the order of 38%. In addition, commodity prices account for around 42% and 61% of the variation in consumption and investment growth, respectively. We find transitory productivity shocks to be an important driver of output fluctuations, exceeding the contribution of shocks to the trend, which is smaller, although not negligible.

Domestic Policies and Sovereign Default

“…We also conduct this comparison using contemporaneous regressions between these three variables and the terms of trade. The estimated semi-elasticities, similar to those in Drechsel and Tenreyro (2017), are quite similar in the model and the data and resemble the effect at time zero in the analysis presented here.…”

“…Underpredicting the volatility of these variables is to be expected given that the model only has one shock driving all fluctuations. 21 In the empirical literature, the percent of fluctuations in output accounted for by terms-of-trade shocks varies between about 10% to 40% depending mostly on the country and period considered (Drechsel and Tenreyro, 2017;Schmitt-Grohé and Uribe, 2018). Our model with only terms-of-trade shocks generates 17% of the variance of GDP in the data.…”

“…In Latin America, there is a long tradition connecting economic performance with the evolution of commodity prices. In recent work, Drechsel and Tenreyro (2017) and Fernández et al (2018) find that the contribution of commodity price shocks to output fluctuations is close to 40%. Poor economic performance is also attributed to government policy, e.g., high fiscal deficits and inflation.…”

“…22 As a comparison, Drechsel and Tenreyro (2017) finds that "a 10 percent deviation of commodity prices from their long-run mean can move Argentina's real interest spread by almost 2 percentage points" (i.e., 200 basis points). Our estimates are more conservative because we include more countries with fewer debt crises than Argentina.…”

“…We use data on terms of trade as described above and the time series of commodity prices used by Drechsel and Tenreyro (2017). Before estimating the autoregressive process, we take logs of the series and subtract the mean.…”