Commodity prices and labour market dynamics in small open economies

We investigate the connection between commodity price shocks and unemployment in
advanced resource-rich small open economies from an empirical and theoretical
perspective. Shocks to commodity prices are shown to influence labour market
conditions primarily through the real exchange rate contrasting sharply with the
transmission of technology shocks which are typically argued to affect the economy by
changing labour productivity. The empirical impact of commodity price shocks is
obtained from estimating a panel vector autoregression; a positive price shock is found
to be expansionary for the components of GDP, causes the real exchange rate to
appreciate, and improves labour market conditions. For every one percent increase in
commodity prices, our estimates suggest a one basis point decline in the unemployment
rate and at its peak a 0.3% increase in unfilled vacancies. We then match the impulse
responses to a commodity price shock from a small open economy model with net
commodity exports and search and matching frictions in the labour market to these
empirical responses. As in the data, an increase in commodity prices raises consumption
demand in the small open economy and induces a real appreciation. Facing higher
relative prices for their goods, non-commodity producing firms post additional job
vacancies, causing the number of matches between firms and workers to rise. As a
result, unemployment falls, even if employment in the commodity-producing sector is
negligible. For commodity price shocks, there is little difference between the standard
Diamond (1982), Mortensen (1982), and Pissarides (1985) approach of modelling search
and matching frictions and the alternating offer bargaining model suggested by Hall and
Milgrom (2008).