Production Networks and the Propagation of Commodity Price Shocks

Fluctuations of commodity prices are frequently associated with the volatility of aggregate output and prices. As commodity prices rise and fall, adjustments take place in the economy, ranging from shifts in investment, employment and output to changes in interest rates and exchange rates. While these adjustments are already quite complex, one important channel often overlooked in the literature is the input-output linkages. In this paper, we examine the macro implications of commodity price shocks in a structural model with input-output linkages for a commodity-exporting small open economy. Calibrated to the Canadian economy, our model can explain a large part of the decline in real gross domestic product (GDP) that we saw in 2015 and 2016 following the sharp drop in commodity prices. We find that as the model economy adjusts to commodity price shocks, domestic downstream linkages and the export connection with the rest of the world play an important role.