IMF paper on how to better manage commodity price cycles

Fund study shows that flexible exchange rate regimes help shield commodity-exporting countries from sudden declines in commodity prices

Exchange rate flexibility can act as a powerful shock absorber for commodity-exporting countries facing volatile terms of trade, according to an International Monetary Fund paper, published on Monday.

Gustavo Adler and Sebastián Sosa, the paper's authors, use data from a sample of 64 emerging and large commodity-exporting advanced economies between 1970 and 2010 to examine the history of commodity price busts and the role of policies in mitigating or amplifying their economic impact. The authors note that while commodity-exporting countries have significantly benefited from the commodity price boom of recent years, uncertainty about the global economic prospects has raised questions about their vulnerability to a sharp fall in commodity prices.

The results show 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 to sharp terms-of-trade drops – especially when those are preceded by booms – play a particularly important role, they say. Limited exchange rate flexibility, a weak external position, and loose fiscal policy tend to amplify the negative effects of these shocks on domestic output.

Click here to read the paper.

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