Commodity prices and production networks in small open economies

Abstract

We study the role of domestic production networks in the transmission of commodity price fluctuations in small open economies. First, we present a tractable model of a small open economy's production network to explain sectoral propagation patterns. We demonstrate that the domestic production network is crucial in shaping the propagation of commodity prices. Using a panel of 31 sectors across 9 small open economies, we empirically confirm the model's predictions. Next, we construct a dynamic model of a small open economy featuring a production network to study the macroeconomic importance of the network structure in shaping both aggregate and sectoral responses to commodity price shocks. We show that: (i) the network-adjusted labor share of the commodity sector, rather than the sector's size, is key to understanding the real wage's response to commodity price fluctuations; and (ii) non-unitary elasticities of substitution in production are crucial for understanding the cross-sectional implications of these fluctuations.