With historic change taking place across North Africa and the Middle East over the last month, oil prices are, not surprisingly, rising. In his latest Fed Watch , Tim Duy tries to determine how much of an impact commodity prices will have on previously rising optimism about the US economy. He shares an exercise that he used in a recent class: The question: What is the impact of a commodity price shock? To gain some direction, construct a four variable vector autoregression of commodity prices, core PCE prices, real GDP, and the federal funds rate. For a commodity price measure, I used the PPI measure for Crude Materials for Further Processing: To implement the model, I took the first difference of the natural log of each of the first three variables (DIFFCOM, DIFFPRICES, DIFFGDP), multiplying each by 100 to convert to percentages. The commodity price measure is quite variable: I estimated the model with 5 quarterly lags over the period 1984:1 to 2010:4. I then generated impulse response functions to examine the impact of an unexpected shock to commodity price inflation: The results suggest that a roughly 8 percentage point increase in commodity prices yields virtually no impact on core inflation, but, after four quarters, drives real GDP growth down .17 percentage points. Monetary policy responds with a .23 percentage point decrease in the fed funds rates after 7 quarters. Of course, in the current zero interest rate environment this response would need to be mimicked with a fresh expansion of the quantitative easing (I have yet to find a satisfactory replacement for the federal funds rate to take into account the zero bound. Topic for future research). Read Duy's bottom line conclusions from the exercise, and more analysis, here .