Commodity Price Cycles (original) (raw)

1 We are very grateful to Nicolás Eyzaguirre, Rodrigo Valdés, Charles Kramer and Luis Cubeddu for their input and feedback. We also thank Camilo Tovar, Herman Kamil and seminar participants at the Central Banks of Colombia, Paraguay and Uruguay, and the IMF's Western Hemisphere Department for their useful comments, and Alejandro Carrión, Marola Castillo and Ben Sutton for their research assistance. A previous version of this work was published as Chapter 3 of the Fall 2011 Regional Economic Outlook-Western Hemisphere. This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. Commodity-exporting countries have significantly benefited from the commodity price boom of recent years. At the current juncture, however, uncertain global economic prospects have raised questions about their vulnerability to a sharp fall in commodity prices and the policies that can shield it from such a shock. To address these questions, this paper takes a long term (4 decade) view at emerging markets' commodity dependence, the history of commodity price busts and the role of policies in mitigating or amplifying their economic impact. The paper highlights the stark difference in trends between Latin America-one of the most vulnerable regions given its high, and rising, commodity dependence-and emerging Asia-which has evolved from being a net exporter to a net importer of commodities in the last 40 years. We find evidence, however, that while commodity dependence is an important ingredient, a country's ultimate degree of vulnerability to commodity price shocks is to a great extent determined by the flexibility and quality of its policy framework. Policies in the run-up of sharp terms-of-trade drops-especially when those are preceded by booms-play a particularly important role. Limited exchange rate flexibility, a weak external position, and loose fiscal policy tend to amplify the negative effects of these shocks on domestic output. Financial dollarization also appears to act as a shock "amplifier."