Abstract 

This paper analyzes the business cycle of a small commodity-exporting economy. Using Chilean data, we show SVAR evidence of the effect of a commodity price shock on the  non-commodity economy. A positive shock to the commodity price leads to an increase in both non-commodity output and employment, a real exchange rate appreciation, an increase in investment and a decrease in the non-commodity trade balance. Moreover, we find that commodity price fluctuations contribute to 40 percent of the variance of non-commodity output. We build a theoretical three-sector model where the commodity good is produced with a technology that requires non-tradable investment and intermediate goods. An increase in the price of commodity rises the demand and the price of non-tradable goods. It also induces a factor reallocation and an increase in total labor demand, leading to an expansion of the non-commodity economy. Our quantitative results have a good fit to the data and emulate reasonably well the dynamic response of the non-commodity economy to a commodity price shock.