4.2 Transmission via commodity prices

As noted in subsection 3.2, the evolution of commodity prices is important for the New Zealand economy. Indeed, as discussed by Bowman and Conway (2013a, 2013b), growth in China over the last decade may be particularly important as an explanation of the rise in commodity prices, which affects New Zealand as an exporter of primary products. Related to this, Roache (2012) investigates the impact of shocks to aggregate activity in China on real prices of oil and base metals (relative to the US consumer price index) for the period 2000-2011; while shocks to aggregate activity in China have a significant and persistent short-run impact on the prices of oil and copper, they are generally insignificant for other metals. However, Roache (2012) also finds that effects are larger for a demand shock originating in the United States than in China. In the Australian context, the results of Sun (2011) indicate that commodity prices are the most important channel for the transmission of shocks from emerging Asia to Australia over her sample from 2000, with some results (Sun, 2011, Figure 9) suggesting that these are important also for the transmission of shocks from that region to New Zealand. Nevertheless, this latter analysis is not entirely satisfactory in that commodity prices are treated as exogenous to even the world's largest economies.

Against this background, and also the results of our baseline SVAR presented in subsection 4.1, it is useful to investigate empirically the role of commodity prices in the transmission of growth spillovers to the New Zealand economy. Since Roache (2012) finds that the US is more important for the evolution of commodity prices than China, our SVAR model includes GDP growth for both of these large economies in a single specification and, reflecting their importance for world demand, the model allows growth in both China and the US to contemporaneously influence commodity prices. In recognition of the historical role of the US for the world business cycle, contemporaneous causality between these countries runs from the US to China. However, unrestricted lags apply across these two countries and commodity prices. This block is exogenous for Australia and New Zealand, so that growth in China and the US affects these countries, but not vice versa. Due to the availability of commodity price data, the estimation period for the extended SVAR starts in 1986. A schematic representation of the model description is provided in Appendix Figure 1.

Figure 7 shows the estimated responses of all eight variables to a one percentage point shock to China's growth rate in this extended model that employs the real aggregate ANZ commodity price index. Although there is virtually no effect on the US from the China growth shock, the commodity price index responds positively, increasing by about 0.7 percent within the quarter, and the effect is rather persistent and statistically significant. The pattern of response of domestic output is similar to the output response to a China shock shown in Figure 3, albeit with the estimated mean response being a little lower than in the baseline case. The real exchange rate immediately appreciates in response to the increase in China's output and the associated boost in commodity prices, while interest rates and inflation responses are small and insignificant.

Figure 7: Responses to China GDP shock with commodity price channel

Notes: The figure depicts the impulse responses to a one-percentage point orthogonalised shock to China's GDP. The SVAR model includes the aggregate commodity price index and is estimated using data over 1986Q1 to 2011Q4. The solid line shows the estimated mean response, with the shaded bands indicating the 90 percent confidence interval, obtained using 2000 Monte Carlo replications. Responses are shown for the quarter of the shock (quarter 1) and 9 subsequent quarters. Source: Authors' calculations.

A comparison of the responses to a US shock in Figure 8 with those just discussed for a China shock reveals a number of interesting differences. Firstly, in line with the results of Roache (2012) for oil and base metals, the response of commodity prices to a US growth shock in Figure 8 is around double that seen when growth originates in China (Figure 7). Although this stronger effect is partly due to the contemporaneous causal ordering we adopt between these large economies, it also reflects the wider impact of the US on the world economy over most of the 1986-2011 period[8]. Secondly, the peak GDP responses of New Zealand occur in the quarter after the shock, in line with the estimates from the baseline model of subsection 4.1, but in contrast to the responses to a China shock.

Figure 8: Responses to US GDP shock with commodity price channel

Notes: The figure depicts the impulse responses to a one-percentage point orthogonalised shock to US GDP. The SVAR model includes the aggregate commodity price index and is estimated using data over 1986Q1 to 2011Q4. The solid line shows the estimated mean response, with the shaded bands indicating the 90 percent confidence interval, obtained using 2000 Monte Carlo replications. Responses are shown for the quarter of the shock (quarter 1) and 9 subsequent quarters. Source: Authors' calculations.

Further, using the extended model Figure 8 reveals some differences in responses to US shocks compared with the baseline case (Figure 4). In particular, in omitting both China and commodity prices when analysing the responses to US shocks, the baseline model conflates the appreciation of New Zealand's real exchange rate that operates through those sources with an anticipated negative direct effect from a US shock, with these shocks more adequately isolated in the extended model.

These results suggest that commodity prices play an important role in the transmission of shocks from both China and the US to New Zealand. These effects operate partly through Australia, which itself strongly influences Australia's domestic growth (Figure 5). The positive and significant response of the real exchange rate in Figure 7 is another manifestation of the importance of commodity prices. Although results are not shown, a one percent shock to the real commodity price index increases this variable by around 0.4 percent, which is significant and implies that this channel makes an important contribution to the impact response of the real exchange rate seen in Figure 7. These results on the role of commodity prices are in line with findings of Karagedikli and Price (2012) and Jääskelä and Smith (2011), who study the sources of terms of trade shocks for New Zealand and Australia, respectively.