Commodity price shocks and the business cycles in emerging economies: the role of banking system balance sheets

This paper studies the role of banks in the transmission of commodity price shocks in emerging economies when they have access at external debt nominated in a foreign currency to finance their credit operations. Using a SVAR model for six Latin American countries, we find that a positive commodity price shock generates a credit and output expansion up to 46% higher in the presence of banks' balance sheets effects compared with a model when this mechanism is not considered. We also show that the inclusion of financial system variables in the model improves its capacity to replicate the trajectory and volatility of the business cycle. These findings reinforce the necessity to explicitly include the role of the financial system in the explanation of credit and business cycles of emerging economies in the presence of price shocks, contrary to current literature practice. Moreover, it underlines the importance of recent literature studying the effects of financial globalization and potential economic policies (exchange rate policy, macroprudential policy and/or capital controls) to soften the macroeconomic impact of these types of shocks.