Production networks and the propagation of commodity price shocks

We examine the macro implications of commodity price shocks in a general equilibrium model with input-output linkages for a commodity-exporting small open economy. In the model, fluctuations in commodity price affect aggregate output not only through resource reallocation, currency value changes and monetary policy reaction, but also through upstream and downstream input-output linkages (both domestically and with the rest of the world). Calibrated to the Canadian economy, our model is able to explain a large part of the decline in real gross domestic product (GDP) in 2015 and 2016 following the sharp drop in commodity prices. We find that as the model economy adjusts to a commodity price shock, domestic downstream linkages and the export connection with the rest of the world play an important role.