Emerging markets and developing economies (EMDEs) are particularly exposed to the global economy's fluctuations, primarily due to their reliance on primary commodity exports. This dependency makes them vulnerable to commodity price volatility and ties their economic performance closely to the global financial cycle. Traditionally, the global financial cycle has been linked to shifts in US monetary policy and fluctuations in global risk perception. The role of commodity prices in the GFC has gained increased attention in recent studies. Davies et al. (2021) and Miranda-Agrippino and Rey (2021) highlight the importance of commodity prices in shaping the global financial cycle. However, the specific mechanisms through which global shocks impact EMDEs and the role of commodity prices in this process remain unclear. A key open question is whether commodity prices predominantly propagate global shocks or are themselves a source of shock. Figure 1 shows how export prices relate to the business cycles of EMDEs and to the Baa spread, which we use as a summary indicator of global financial conditions.
Figure 1 Export prices, EMDEs business cycles, and the global financial cycle
Notes: Panel (a) displays the cross-sectional average of export prices (Px) and GDP, both expressed as percentage deviations from their respective quadratic trends, for a panel of 54 EMDEs. Panel (b) shows the change in the cross-sectional average of export prices alongside the negative of the changes in the Baa spread, lagged by one year.
In new research (Juvenal and Petrella 2024), we contribute to this debate by analysing the dual role of commodity prices both as an independent source of shocks and as transmitters of two key shocks associated with the global financial cycle, namely, changes in US monetary policy and global risk appetite. Our findings reveal that surges in export prices, triggered by commodity price shocks, boost domestic GDP. Eased global credit conditions, attributed to looser US monetary policy or lower global risk appetite, lead to higher export prices and output. The endogenous response of export prices is particularly important in amplifying the transmission of US monetary policy to EMDEs. Countries exposed to commodity markets whose prices are more sensitive to shifts in interest rates have GDP responses up to twice as large as the average. Finally, changes in US monetary policy and global risk appetite are key drivers of capital flows in these economies.
The dual role of commodity prices
What role do commodity prices play in shaping the business cycle and transmitting the global financial cycle to developing countries? Figure 2 presents a comprehensive conceptual framework that serves as a guide for our analysis. As depicted in the center of the chart, commodity prices are intrinsically linked to global demand conditions and global financial conditions. Higher global growth boosts the demand for commodities, leading to an increase in their prices. Moreover, a decrease in interest rates and improved financial conditions generally reduce inventory-holding costs, fueling the demand for commodities and causing their prices to rise (Frankel 1986, 2008).
Global financial conditions, in turn, affect global economic activity (e.g. Caldara et al. 2016) and, through this channel, also commodity prices. Simultaneously, fluctuations in commodity prices shape global demand both directly, as demonstrated in studies on oil prices (Hamilton 1983) and agricultural prices (De Winne and Peersman 2016), and indirectly. Higher commodity prices can trigger domestic inflation in major economies, prompting central banks to respond (e.g. Mishkin 2007), consequently influencing global financial conditions and global demand. Ultimately, output is affected through different channels, but the source of the shock can matter for the transmission mechanism.
Given this, it is essential to distinguish between two types of commodity price fluctuations: endogenous shifts resulting from global shocks and their subsequent impact on transmitting and amplifying these shocks to the business cycles of EMDEs, and commodity price shocks originating from idiosyncratic disturbances within commodity markets themselves.
Figure 2 Commodity prices and the global financial cycle: A conceptual framework
Methodology
To identify the effects of the shocks of interest on GDP, we rely on a panel local projection method with instrumental variables (Cloyne et al. 2023, Jordá et al. 2020). To assess the impact of exogenous shifts in commodity prices on EMDEs, we identify the causal effects of changes in export prices associated with major exogenous disruptions in specific commodity markets. For this purpose, we develop an instrument leveraging the heterogeneity in countries' exposure to events like severe weather, geopolitical turmoil, or natural disasters. In addition, we investigate the role of commodity prices on the transmission and amplification of global shocks. This includes analysing the response of export prices and other macroeconomic variables to easing global financial conditions, represented by a decline in the Baa spread. We distinguish between Baa movements driven by exogenous shifts in US monetary policy and those caused by changes in global risk appetite. Both factors are widely recognised as the key drivers of the global financial cycle (Kalemli-Ozcan 2019, Miranda Agrippino and Rey 2020).
Key findings and analysis
We provide evidence highlighting that export price booms, resulting from commodity shocks and global shocks associated with the global financial cycle, lead to significant export price increases and an expansion in economic activity. This is illustrated in Figure 3. Export price booms driven by commodity shocks have a robust positive effect on output (top panels). Global shocks associated with the global financial cycle are accompanied by a sustained increase in commodity prices and export prices (Px) for EMDEs (bottom panels). This contributes to a significant expansion in economic activity following a benign turn of the global financial cycle. However, a striking contrast exists between the impact of a reduction in the Baa spread depending on whether they originate in changes in US monetary policy or global risk sentiment. First, a global risk appetite shock typically results in a more temporary effect, with impulse responses displaying a spike-like pattern in GDP and export prices (magenta lines). Second, the reaction of export prices and output to a US monetary policy shock displays a similar humped-shaped response, suggesting that the influence of US monetary policy on EMDEs is shaped by the impact this has on commodity prices (blue lines).
Figure 3 Transmission of global shocks
Notes: The top panels report the impulse responses of GDP and export prices (Px) to a (one standard deviation) increase in export prices driven by commodity price shocks (in black). The bottom panels report the impulse responses of a (one standard deviation) decline in the BAA spread driven by a more accommodative US monetary policy (in blue) and shifts in global risk appetite (in magenta). Shaded areas denote 68% and 90% confidence intervals.
Global shocks (US monetary policy and changes in global risk appetite) are transmitted through different channels. To illustrate this point, we examine the transmission of global shocks to the GDP of EMDEs, differentiating between two groups of countries: those that experience a substantial increase in export prices following an expansionary global shock (orange line, Figure 4) and those that exhibit a more modest export price increase (dotted black line, Figure 4), possibly due to their exposure to less price-sensitive commodities. The analysis reveals that endogenous shifts in commodity prices play a crucial role in the international transmission of US monetary policy to EMDEs. Conversely, the endogenous response of commodity prices appears to be a less significant factor in determining the transmission of global risk shocks to these economies.
Figure 4 Commodity prices and the transmission of the global financial cycle to GDP
Notes: This figure illustrates the variability in the GDP response as a function of the endogenous shift in Px. The orange lines report the response for which export prices endogenously increase more than on average after an expansionary shift in (a) U.S. monetary policy and (b) global risk appetite. The dotted black lines report the responses for which export prices endogenously increase less than on average. Shaded areas denote 68% and 90% confidence intervals.
Conclusion
Our analysis underscores the significant impact of export price fluctuations, driven by idiosyncratic events in commodity markets, on the business cycles of EMDEs. Moreover, we highlight that the endogenous reaction of commodity prices to global shocks is a key component of the international transmission of the drivers of the global financial cycle. Notably, our findings reveal that countries with more price-sensitive commodity exports exhibit heightened vulnerability to shifts in US monetary policy.
These results reiterate the importance of policies promoting export diversification to mitigate the impact of external shocks on EMDEs. This is especially crucial for countries that heavily depend on primary commodity exports, as their economic stability is more susceptible to global market fluctuations.
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