The impact of commodity price shocks in the presence of a trading relationship: A GVAR analysis of the NAFTA

This paper investigates the commodity price shocks and monetary shocks in the region covered by the North American Free Trade Agreement (NAFTA), using a global vector autoregression (GVAR) approach. Our focus is on commodity price shocks which impact both directly through the aggregate price level, as well as through monetary policy related aggregates such as short-term interest rates. We first contrast the response of the real economy to commodity price shocks in two periods: 1983Q2–2015Q2 and 1994Q1–2015Q2, where the beginning of the second sample coincides with a statistically identified structural break, as well as the introduction of NAFTA. The results indicate that the commodity price shocks, such as for oil and metal, have a bigger impact on the real economy after NAFTA came into force, with metal prices having a larger quantitative impact on output in comparison to oil prices. Next, we investigate whether these changes have different implications for the impact of domestic monetary shocks in the three countries. We find that while the post-NAFTA period is characterized by a stronger domestic monetary policy response to commodity price shocks, the response to monetary shocks per se varies in the two time periods. In particular U.S. monetary policy, as reflected in shocks to short-term interest rates, has a weaker influence in the post-NAFTA period. Overall, the influence of global, commodity price shocks in the region relative to domestic monetary shocks is greater in the post-NAFTA period.