Commodity prices and global economic activity: A derived-demand approach

Abstract

This paper studies the interaction between commodity prices and global economic activity in a setup where a representative cost-minimizing firm chooses optimal inputs as derived demands. Our focus is on important globally traded commodities, whose supply function is very price inelastic in the short run. Key examples studied here are Oil and major metal commodities, such as Aluminum, Copper and Nickel. Our empirical evidence fully supports the theoretical results of the derived-demand model. Indeed, this paper shows overwhelming evidence that cycles in oil prices are synchronized to those of global industrial production. This evidence is stronger regarding the global economy but holds as well for the U.S. economy. Our first original contribution is to investigate and find common cycles accounting for theory and empirics.