Commodity Price Cycles and Financial Stability

Abstract

Commodity exporter economies usually suffer when a boom in commodity prices ends, especially if the cycle ends abruptly. Furthermore, recent literature has highlighted the role of financial instability as either causing or aggravating financial and real crises. In this paper we look at these two aspects, and study the relationship between commodity prices, output growth and financial stability, the latter proxied by domestic credit growth. Given the asymmetry we observe in boom and bust cycles, we estimate the output cost of commodity price shocks on separate samples, with a special emphasis in emerging economies. In particular, we focus on the output cost of a commodity price reversal given the credit increase observed during a boom event. We find that, in line with previous literature, the correlation between commodity shocks and output growth decreases as economies are more open to financial markets. The novelty is that we also find that this correlation is higher when countries experience very rapid credit growth during the Upturn phase of a boom. That is, rapid credit growth –regardless of its initial level—exacerbates the cost of a commodity price reversal.