## WP/17/208 — The Adjustment to Commodity Price Shocks in Chile, Colombia, and Peru ## Source details **Canonical URL:** [WP/17/208 — The Adjustment to Commodity Price Shocks in Chile, Colombia, and Peru](https://www.imf.org/-/media/files/publications/wp/2017/wp17208.pdf) ## Other formats - [Markdown version](/-/media/files/publications/wp/2017/wp17208.pdf.md) - [Structured JSON version](/-/media/files/publications/wp/2017/wp17208.pdf.json) --- ### Introduction and key messages - The “commodity super-cycle” ended as commodity prices decreased steadily since 2011; in Chile and Peru the terms of trade doubled from 2000 to 2011, and in Colombia they increased by 70 percent over the same period. - Metal prices began their downward adjustment in 2011, while oil prices started to decline since mid-2014; Chile and Peru are in the final stages of adjustment, while Colombia is in the midst of adjusting to more recent oil price declines. - Flexible exchange rates are important to facilitate adjustment to lower commodity prices; monetary authorities need to stay vigilant and tighten monetary policy to address depreciation pressures on inflation. - Greater fiscal space, as observed in Chile and Peru, gives more room to accommodate terms-of-trade (ToT) shocks. ### Data and methodology - Estimation approach: - Country-by-country VARs are estimated, mostly using a country-specific bivariate VAR specification; for external variables a three-variable VAR is estimated (REER, current account, commodity price index). - Identification of structural shocks uses a Cholesky decomposition, assuming domestic variables do not affect the terms of trade contemporaneously. - Number of lags chosen based on the Aikaike information criterion. - Data characteristics: - Quarterly data from the first quarter of 1999 until the last quarter of 2015. - A country-specific commodity price index constructed by Gruss (2014) is used; the index assigns weights based on net exports of each commodity to capture net income effects. - Domestic series are seasonally adjusted; series are log-differenced except for the current account balance, which is expressed as a percentage of GDP. ### VAR impulse-response results — fiscal and output responses - Primary public expenditures: - Chile: a one standard deviation shock to commodity prices leads to a one percent decline in primary expenditure. - Peru: the same shock leads to an increase of 2 percent in primary expenditures. - Colombia: primary expenditures are insensitive to commodity price shocks after some initial volatility. - Public revenues (accumulated responses): - Chile: around 8 percent after 4 quarters. - Colombia: peaks at 4 percent after 3 quarters. - Peru: peaks at 1.5 percent after 3 quarters. - Real GDP growth: - Initial responses during the first two quarters are broadly similar across Chile, Colombia, and Peru. - In the medium term, Peru benefits the most from a positive ToT shock. ### VAR impulse-response results — external sector responses - Real effective exchange rate (REER): - Chile and Colombia: a positive commodity price shock leads to an appreciation of the REER, with a stronger appreciation in Colombia. - Peru: a slight depreciation of the REER is observed, potentially explained by active intervention policy of the Central Reserve Bank of Peru. - Current account: - All three economies: the current account improves after a positive ToT shock. - Chile: stronger positive effect; over the medium term the current account improves more in Chile, with an average response of around 2 percent. - Colombia and Peru: adjust in similar ways during the initial five quarters. ### Forecast error variance decomposition — quantitative importance of ToT shocks - Contribution of commodity price movements to primary expenditures (10-quarter horizon): - Chile: about 5 percent. - Peru: about 5 percent. - Colombia: 2 percent. - Contribution of commodity price movements to public revenues (10-quarter horizon): - Chile: 25 percent. - Peru: 20 percent. - Colombia: roughly 3 percent. - Contribution of commodity prices to variance of real GDP: on average 10 percent across Chile, Colombia, and Peru. - Contribution to REER variance: Chile around 34 percent; Colombia around 24 percent. ### Event study: timing, size, and immediate impacts - Timing differences: - Copper decline: t = 2011Q1 for Chile and Peru. - Oil decline: t = 2014Q2 for Colombia. - Speed and magnitude: - Oil prices plunged by about 40 percent in 5 quarters (Colombia). - Copper prices took 18 quarters to decrease by 45 percent (Chile and Peru). - Terms of Trade (ToT) impacts: - These large commodity price shocks deteriorated the ToT substantially, with Colombia experiencing the largest impact. - The contribution of the ToT to Gross National Disposable Income after the shock was negative and sizeable, especially in Colombia. ### Exchange rate and current account adjustments - REER adjustments: - Chile’s REER had depreciated by 5 percent by the end of its adjustment process. - Colombia experienced a sharp and fast real depreciation of around 18 percent. - Peru had a minor real appreciation of about 6 percent. - Current account outcomes: - Peru’s current account deficit deteriorated from 2 percent of GDP in 2011 to 4.4 percent of GDP in 2015. - Chile: the exchange rate adjustment allowed for a significant adjustment in the current account; the deficit was roughly zero after 18 quarters. - Colombia: the current account deteriorated as a result of the oil price decline and had yet to reflect the adjustment in quantities. ### Composition of adjustment: imports, exports, and FDI - Chile: - Most of the adjustment in the current account came from import contraction (imports declined from 35 to 30 percent of GDP). - The initial widening of the current account deficit was due to decline in value of traditional exports; non-traditional exports did not materially pick up. - Peru: - No significant fluctuations in non-traditional exports and imports; current account remained stickier and FDI more stable. - Financial flows: - Direct and portfolio investment trends accompanied current account movements for Chile and Peru. ### Inflation, monetary policy, and credibility - Depreciation of currencies created inflationary pressures in all three countries. - Central banks raised policy rates to keep inflation inside the target range; monetary tightening also aimed to moderate domestic demand in Colombia to contain the widening current account deficit. - These timely policy actions supported the credibility of the inflation targeting regimes and contained inflationary pressures. - Where ToT shocks started about five years ago (Chile and Peru), inflation is already moving back toward the target range; markets expect the same in Colombia. ### Fiscal responses and public finances - Primary balances deteriorated steadily in all three countries following the shocks. - Commodity price shocks reduced commodity-related revenues, reflected in lower growth rates of public revenues observed after the shock. - Public expenditures: - Except for Colombia, the growth rate of public expenditures remained broadly stable. - Chile and Peru, which exhibited primary surpluses at the time the shock hit, had more room to implement a gradual fiscal adjustment; Colombia was already featuring a primary deficit. - Impulse-response analysis: - Public spending tends to be more procyclical in Peru than in Chile after ToT shocks. - Public spending tends not to react to ToT shocks in Colombia. - Policy implication emphasized: the importance of having a fiscal buffer to smooth negative effects of external shocks is a key consideration for fiscal policy in Peru going forward. ### Domestic demand and real GDP dynamics - Total domestic demand slowed in all three countries at the time the shock hit. - The initial slowdown in Chile and Peru was significantly more abrupt than in Colombia. - In the final stages of the transition, Chile had a stronger adjustment in domestic demand than Peru. - Real GDP growth: - Chile and Peru: real GDP growth decreased continuously after the fall in their terms of trade. - Colombia: GDP growth declined after oil prices started plunging. - Despite slowdowns, robust policy frameworks allowed positive growth rates to be maintained; GDP growth has started to recover in Peru. ### Forward-looking projection and policy conclusions - Exchange rate flexibility: - More exchange rate flexibility underpins faster current account adjustments to ToT shocks; rapid depreciation in Chile was a key factor behind full adjustment of its current account deficit. - Peru’s active FX intervention likely muted real depreciation, contributing to a persistent current account deficit of 4.4 percent of GDP by 2015. - Outlook for Peru: - A continued gradual real depreciation of the sol and an increase in mining exports are expected to halve the Peruvian current account deficit by 2021. - Overall conclusions: - Despite slowdowns, GDP growth remained resilient in Chile, Colombia, and Peru due to sound policy frameworks. - Fiscal loosening in Chile and Peru likely contributed to smoothing the adjustment to the shock, enabled by wider fiscal space relative to Colombia. - Robust monetary frameworks limited inflation responses to ToT shocks through communication and policy rate hikes. *Source: WP/17/208 — The Adjustment to Commodity Price Shocks in Chile, Colombia, and Peru (Sections 1–3).* ### Section 1 ### WP/17/208 — The Adjustment to Commodity Price Shocks in Chile, Colombia, and Peru (Section 1) ### Introduction and key messages - The “commodity super-cycle” ended as commodity prices decreased steadily since 2011; in Chile and Peru the terms of trade doubled from 2000 to 2011, and in Colombia they increased by 70 percent over the same period. - Metal prices began their downward adjustment in 2011, while oil prices started to decline since mid-2014; Chile and Peru are in the final stages of adjustment, while Colombia is in the midst of adjusting to more recent oil price declines. - Flexible exchange rates are important to facilitate adjustment to lower commodity prices; monetary authorities need to stay vigilant and tighten monetary policy to address depreciation pressures on inflation. - Greater fiscal space, as observed in Chile and Peru, gives more room to accommodate terms-of-trade (ToT) shocks. ### Data and methodology - Estimation approach: - Country-by-country VARs are estimated, mostly using a country-specific bivariate VAR specification; for external variables a three-variable VAR is estimated (REER, current account, commodity price index). - Identification of structural shocks uses a Cholesky decomposition, assuming domestic variables do not affect the terms of trade contemporaneously. - Number of lags chosen based on the Aikaike information criterion. - Data characteristics: - Quarterly data from the first quarter of 1999 until the last quarter of 2015. - A country-specific commodity price index constructed by Gruss (2014) is used; the index assigns weights based on net exports of each commodity to capture net income effects. - Domestic series are seasonally adjusted; series are log-differenced except for the current account balance, which is expressed as a percentage of GDP. ### VAR impulse response results — fiscal and output responses - Primary public expenditures: - Chile: a one standard deviation shock to commodity prices leads to a one percent decline in primary expenditure. - Peru: the same shock leads to an increase of 2 percent in primary expenditures. - Colombia: primary expenditures are insensitive to commodity price shocks after some initial volatility. - Public revenues: - Chile: accumulated response of public revenues is around 8 percent after 4 quarters. - Colombia: accumulated response peaks at 4 percent after 3 quarters. - Peru: accumulated response peaks at 1.5 percent after 3 quarters. - Real GDP growth: - Initial responses during the first two quarters are broadly similar across Chile, Colombia, and Peru. - In the medium term, Peru benefits the most from a positive ToT shock. ### VAR impulse response results — external sector responses - Real effective exchange rate (REER): - Chile and Colombia: a positive commodity price shock leads to an appreciation of the REER, with a stronger appreciation in Colombia. - Peru: a slight depreciation of the REER is observed, potentially explained by active intervention policy of the Central Reserve Bank of Peru. - Current account: - All three economies: the current account improves after a positive ToT shock. - Chile: stronger positive effect; over the medium term the current account improves more in Chile, with an average response of around 2 percent. - Colombia and Peru: adjust in similar ways during the initial five quarters. ### Forecast error variance decomposition — quantitative importance of ToT shocks - Contribution of commodity price movements to primary expenditures (10-quarter horizon): - Chile: about 5 percent. - Peru: about 5 percent. - Colombia: 2 percent. - Contribution of commodity price movements to public revenues (10-quarter horizon): - Chile: 25 percent. - Peru: 20 percent. - Colombia: roughly 3 percent. ### Implications highlighted by Section 1 - Exchange rate flexibility acts as an important buffer for adjustment to ToT shocks, but adjustment in these cases has occurred mainly through import compression rather than a surge in non-traditional exports. - Substantial exchange rate pass-through to inflation has been observed; tightening under inflation-targeting regimes has been effective in directing inflation back toward target ranges. - Fiscal frameworks with greater space and rules (as in Chile and Peru) appear to allow more accommodation and counter-cyclical policy in response to ToT shocks. *Source: WP/17/208 — The Adjustment to Commodity Price Shocks in Chile, Colombia, and Peru (Section 1).* ### Section 2 ### wp17208 - Section 2 ### Role of commodity price fluctuations - Commodity price fluctuations play a remarkable role in accounting for variations in GDP, the REER, and the current account. - The contribution of commodity prices shocks to the variance of real GDP is on average 10 percent, broadly similar in Chile, Colombia, and Peru. - Commodity price variation accounts for a large part of the variance in the REER, especially in Chile and Colombia where the contributions are estimated at around 34 and 24 percent respectively. - Fluctuations in commodity prices account for a significant part of the variance of the current account, with a larger share in Chile and Colombia. ### Event study: timing, size, and immediate impacts - Timing differences: - The price of copper has been declining since 2011; t = 2011Q1 for Chile and Peru. - The oil price decline began in the second half of 2014; t = 2014Q2 for Colombia. - Speed and magnitude: - Oil prices plunged by about 40 percent in 5 quarters (Colombia). - Copper prices took 18 quarters to decrease by 45 percent (Chile and Peru). - Terms of Trade (ToT) impacts: - These large commodity price shocks deteriorated the ToT substantially, with Colombia experiencing the largest impact. - The contribution of the ToT to Gross National Disposable Income after the shock was negative and sizeable, especially in Colombia. ### Exchange rate and current account adjustments - Real effective exchange rate (REER) adjustments: - Chile’s REER had depreciated by 5 percent by the end of its adjustment process. - Colombia experienced a sharp and fast real depreciation of around 18 percent. - Peru had a minor real appreciation of about 6 percent. - Current account outcomes: - Peru’s current account deficit deteriorated from 2 percent of GDP in 2011 to 4.4 percent of GDP in 2015. - In Chile the exchange rate adjustment allowed for a significant adjustment in the current account; the deficit was roughly zero after 18 quarters. - In Colombia the current account deteriorated as a result of the oil price decline and had yet to reflect the adjustment in quantities. ### Composition of adjustment: imports, exports, and FDI - Chile: - Most of the adjustment in the current account came from import contraction (imports declined from 35 to 30 percent of GDP). - The initial widening of the current account deficit was due to decline in value of traditional exports; non-traditional exports did not materially pick up. - Peru: - No significant fluctuations in non-traditional exports and imports; current account remained stickier and FDI more stable. - Financial flows: - Figures indicate direct and portfolio investment trends alongside current account movements for Chile and Peru (time series presented in source). ### Inflation, monetary policy, and credibility - The depreciation of currencies created inflationary pressures in all three countries. - Central banks raised policy rates to keep inflation inside the target range; monetary tightening also aimed to moderate domestic demand in Colombia to contain the widening current account deficit. - These timely policy actions supported the credibility of the inflation targeting regimes and contained inflationary pressures. - Where ToT shocks started about five years ago (Chile and Peru), inflation is already moving back toward the target range; markets expect the same in Colombia. ### Fiscal responses and public finances - Primary balances deteriorated steadily in all three countries following the shocks. - Commodity price shocks reduced commodity-related revenues, reflected in lower growth rates of public revenues observed after the shock. - Public expenditures: - Except for Colombia, the growth rate of public expenditures remained broadly stable. - Chile and Peru, which exhibited primary surpluses at the time the shock hit, had more room to implement a gradual fiscal adjustment; Colombia was already featuring a primary deficit. - The impulse-response analysis suggests: - Public spending tends to be more procyclical in Peru than in Chile after ToT shocks. - Public spending tends not to react to ToT shocks in Colombia. - Policy implication emphasized: the importance of having a fiscal buffer to smooth negative effects of external shocks is a key consideration for fiscal policy in Peru going forward. ### Domestic demand and real GDP dynamics - Total domestic demand slowed in all three countries at the time the shock hit. - The initial slowdown in Chile and Peru was significantly more abrupt than in Colombia. - In the final stages of the transition, Chile had a stronger adjustment in domestic demand than Peru. - Real GDP growth: - Chile and Peru: real GDP growth decreased continuously after the fall in their terms of trade. - Colombia: GDP growth declined after oil prices started plunging. - Despite slowdowns, robust policy frameworks allowed positive growth rates to be maintained; GDP growth has started to recover in Peru. ### Forward-looking projection and policy conclusions - Exchange rate flexibility: - More exchange rate flexibility underpins faster current account adjustments to ToT shocks; rapid depreciation in Chile was a key factor behind full adjustment of its current account deficit. - Peru’s active FX intervention likely muted real depreciation, contributing to a persistent current account deficit of 4.4 percent of GDP by 2015. - Outlook for Peru: - A continued gradual real depreciation of the sol and an increase in mining exports are expected to halve the Peruvian current account deficit by 2021. - Overall conclusions: - Despite slowdowns, GDP growth remained resilient in Chile, Colombia, and Peru due to sound policy frameworks. - Fiscal loosening in Chile and Peru likely contributed to smoothing the adjustment to the shock, enabled by wider fiscal space relative to Colombia. - Robust monetary frameworks limited inflation responses to ToT shocks through communication and policy rate hikes. *Source: wp17208 - Section 2.* ### Section 3 ### Section 3 ### Content overview - This section contains bibliographic references only and does not present substantive findings, projections, analysis, or policy recommendations. - No numeric data, econometric results, or policy prescriptions are provided in this content unit. *Source: wp17208 - Section 3* --- _Source: https://www.imf.org/-/media/files/publications/wp/2017/wp17208.pdf_