Commodity Prices and Business Cycles in Small Open Economies: The Role of News Shocks

In this paper, we explore the hypothesis that some movements in commodity prices are anticipated and can trigger aggregate fluctuations in the context of a dynamic stochastic general equilibrium model. The model is a... [ view full abstract ]

In this paper, we explore the hypothesis that some movements in commodity prices are anticipated and can trigger aggregate fluctuations in the context of a dynamic stochastic general equilibrium model. The model is a multi-sector small open economy model, with endogenous commodity production, featuring three real rigidities: internal habit formation, capital adjustment costs and working capital constraint. There are five exogenous processes: a productivity shock for each sector, a country-specific interest rate shock that responds to commodity price fluctuations, and a commodity price shock composed by an unanticipated and anticipated component. Agents receive news about future movements in commodity prices with two and four periods in advance. We show that "News" shocks lead to higher real output, investment and consumption, and to a counter-cyclical movement in the trade-balance-to-output ratio. We also show that "News" shocks are a non-negligible source of business cycles in small open economies, accounting for around 15% of fluctuation in output and consumption and even larger shares of the fluctuations in investment, labor and the trade balance-to-output ratio.