Foreign shocks and aggregate price fluctuations in a small commodity exporter economy

Abstract

This paper examines the role of foreign shocks on aggregate prices in the small net commodity exporter economy of Paraguay. I apply a bayesian methodology for variable choice in VARS and and find that foreign variables such as those reflecting regional financial risk and commodity prices are highly relevant in the prediction of aggregate prices in Paraguay. Next, I estimate an over-identified SVAR model with block exogeneity restrictions in order to quantify the effect of shocks in commodity prices and regional risk on key variables, namely the Consumer Price Index, Food CPI, the exchange rate, a monthly indicator of output and the nominal interest rate. Commodity prices shocks explain a substantial percentage of movements in almost all domestic variables, particularly CPI and its food component.