Navigating Uncertain Waters: A Bayesian Threshold VAR Approach to Understanding the Impact of Commodity Price Shocks on Inflation

Abstract: The Covid-19 pandemic in early 2020 led to unprecedented uncertainty, reducing the predictability of macroeconomic variables. At the same time, commodity price movements as a contributor to national consumer price inflation continue to surface in debates. Considering these two phenomena, the question arises whether heightened global uncertainty affects the pass-through of international commodity prices to national consumer prices. To our knowledge, this paper is the first to discuss the role of uncertainty in this context. We focus on the effects for a small open economy, i.e. Austria. Methodologically, we rely on a Bayesian Threshold Vector Autoregressive model which endogenously assigns observations to a low and high uncertainty regime. Using monthly Austrian data from 1981 to 2022, we show that the pass-through of commodity price shocks to domestic inflation is larger during high uncertainty. Imposing sign restrictions reveals that these results are driven by underlying demand shocks. Conversely, if commodity price spikes are caused by supply shocks, they do not translate into higher domestic inflation. These findings contribute to the literature by presenting new evidence about the impact of macroeconomic uncertainty on the size and speed of the pass-through of international commodity price shocks to national consumer prices. Prompted by these findings, it is prudent for monetary authorities and policy makers to incorporate macroeconomic uncertainty into their decision making.