Despite the emergence of tariffs throughout the world before World War I, the degree of agricultural protection in European countries was in the modest range of 20 percent to 30 percent. These tariff duties did not prevent the expansion of agricultural trade. At the end of World War I, a substantial international division of labor continued in the production of agricultural goods. The second wave of expansion of government intervention in agriculture took place during the economic crisis of the 1920s and 1930s. The pattern of a particular nation’s response to the crises followed lines associated with its net position in international trade.For example, in France,Germany, and Italy rates of protection on foodstuffs more than doubled between 1927 and 1931. Even Britain converted to protectionism in 1931, although the free entry of produce from its empire meant that tariff protection was of limited importance to domestic agriculture. In more recent U. S. history, the recession of the early 1980s, the associated high real rates of interest, high exchange values of the dollar, and slow world economic growth put enormous pressure on agriculture. The macroeconomic environment combined with intervention designed in the 1981 Farm Bill to create embarrassing surpluses and unacceptable levels of resource misallocation. The 1981 U. S. Farm Bill set support and target prices at levels designed for a strong export and price performance in the grain sectors. Due to macroeconomic conditions, however, this scenario failed to materialize. More importantly, the 1981 Bill did not allow for flexibility and, as a result,blackberry container programs sustained high production which led to accUmulations of government owned stocks and agricultural expenditures of crisis proportions.
This mess can be referred to as a ‘~olicy disequilibrium.” Response to this specific policy disequilibrium was the Payment-In-Kind Program of 1983. PIK led to even greater expenditures and failed to alleviate the serious problem of surplus stocks. The path followed by agricultural commodity markets over much of the last two decades closely resembles other markets for freely traded commodities such as gold, silver, platinum, copper, and lumber. Stocks also accumulated for these commodities during the 1970s and early 1980s, suggesting that sectoral conditions and government policies are only a part of the explanation for the behavior of agricultural commodity markets. The search for a complete explanation leads to a multi-market perspective and an investigation of external linkages with other markets. Since 1972, conventional wisdom has placed increasingly less emphasis on the inherent instability in commodity markets and more emphasis on external linkages with other markets. Deregulated credit and banking has resulted in greater exposure of agriculture to conditions in the domestic money markets. Also, the shift from fixed exchange rates to flexible rates, in much of the Western world, exposed commodity markets to international money and real trade flows. The emergence of well-integrated, international capital markets meant that agriculture, through domestic money and exchange rate markets, became more dependent on capital flows among countries. The linkages between commodity and money markets are indeed pervasive. In the United States, farming is extremely capital intensive and debt-to-asset ratios have risen dramatically over the last 10 years. As a result, movements in real interest rates have a significant effect on the cost structure facing agricultural production. Storage and breeding stocks especially are sensitive to interest rates. On the other hand, the influence of interest rates on the value of the dollar affects the demand side for farm goods. The close connection between agriculture’s health and interest rates suggests that this sector is vulnerable to monetary and fiscal policy changes.
It has been argued, with much justification particularly since 1980, that the instability in monetary and fiscal policy has contributed greatly to the instability of agriculture markets.Unstable macroeconomic policies are thought to impose sizable shocks on commodity markets. This would be especially true if agricultural commodity markets have flexible prices while other markets have stickier prices. And, indeed, without governmental price supports, agricultural prices are generally more flexible than non-agricultural prices. This is true in part because contracts for agricultural commodities tend to be written for shorter duration and because biological lags tend to cause agricultural supply to be unresponsive to price changes in the short run. This fixed/flex price model of markets is necessary, but not a sufficient condition, for money non-neutrality to imply overshooting agricultural prices . Overshooting in this context is defined as a price path which exceeds the new eventual price equilibrium. Flex-price commodity markets and fixed-price non-agricultural output markets combined with “small” output responses mean that overshooting in agricultural sector markets will occur even if expectations are formed rationally. Such overshooting results from the spillover effects of monetary and fiscal policy on commodity markets. Given a world of fixed- and flex-price markets, the driving force behind overshooting is the real rate of interest and the ability to arbitrage across markets. When in the short run real interest rates rise above long-run equilibrium rates, immediate pressure arises to drive flexible commodity prices downward . In much of the 1970s, real interest rates were below their long-run equilibrium levels and, for some periods in the 1980s, real interest rates were above. Overshooting combined with ‘myopic” expectations means that ”macro externalities” will be imposed upon the agricultural sector .
In the case of interest rates facing U. S. agriculture, interest rate disequilibrium was even more pronounced due primarily to the relative importance of the Farm Credit System. The System’s organizational structure amplifies the disequilibrium and generates more overshooting than would otherwise result. Within the Farm Credit System, borrowers are, in fact, owners and no dividends are paid to stockholders. As a result, during favorable economic periods, the only way owners might extract benefits generated by the system is by increasing borrowing levels at interest rates below those for the rest of the economy. Indeed, through much of the 1970s, interest rates to farmers were dramatically below general market rates while, during the 1980s, the opposite result was true.Empirical evidence supports the view that agricultural output responses are not sufficiently flexible to counter the tendency for prices to overshoot, and that expectations are, at best, only ”myopicany” rational. Bordo has shown empirically that prices of raw goods respo~d more quickly to changes in money supply than do prices of manufactured goods. Andrews and Rausser have shown that, during the large cyclical downturns of the early 1930s and the early 1980s, prices fell more and quantities less in the agricultural sector than in any of nine other sectors of the U. S. economy. In the case of interest rates, numerous studies have shown that real rates vary significantly across countries,planting blueberries in a pot refuting the old view that they remain constant. These results also suggest that the purchasing power parity assumption does not hold, even approximately. In other words, exchange rate changes do not offset changes in relative price levels across nations. Frankel and Hardouvelis’ study on monetary surprises rejects the flex/flex specification in favor of the fixed/flex specification. Their empirical results show that, when announced money supply turns out to be greater than the public expected, nominal interest rates tend to rise and the prices of basic commodities tend to fall. If the flex/flex specification were correct, then interest rates and commodity markets would either both rise or both fall . The only hypothesis that explains the reactions in both interest rate and commodity markets is that increases in nominal interest rates are also increases in real rates. The public anticipates that the Federal Reserve will reverse any recent fluctuation in money stock, thus increasing interest rates and depressing the real prices of commodities. The aggregate effects of money supply on raw agricultural product prices, retail prices of food products, and the nonfood Consumer Price Index also support empirically the idea of overshooting. Consistent with money nonneutrality and raw agricultural prices being generated by flex-price markets, Stamoulis et al. found the money supply to be a more important determinant in explaining raw product prices than in explaining the nonfood CPI or the index of retail food prices.The linkages discussed above run from the macroeconomic sector to the agricultural food sector. These causal influences may be defined as forward linkages. The most important forward linkages include those observed in the cost structure of production , in general economic conditions and food demand, in inventory behavior and the demand for storage,and in animal breeding stocks.
The macroeconomic variables included in these linkages are interest ratest personal income t and nonfood and general inflation rates. There are effects that run from agriculture to the general economy. These linkages may be defined as backward linkages. There are three main influences on macroeconomy reflected backward from agriculture: on the general inflation rate t on governmental deficits or surplusest and on the balance of trade. These three components cant in turn t have dramatic effects on employment real interest rates, investment t economic growth t and so on. Food prices are a major component of any general price index, and this linkage is important everywhere that the general rate of inflation influences macroeconomic conditions. This is true not only in the demand for money balances, and the willingness of individuals to hold productive and speculative assetst but also in the determination of real wagest real income t and the demand for exports. The linkage through government deficit arises because the outcome for prices, production, private storage, and other variables endogenous to agriculture t determine in part the level of federal spending. As government deficits and expenditures rise, there is a positive effect on consumption and investment. Over the short runt there are multiplier effects leading to further increases in economic activity and in tax revenues, which are a positive function of economic growth. InterestinglYt the operation of government storage and deficiency payments are examples of expenditures that are endogenously determined. This feature is in contrast to much of the non-farm components of the federal budget that are fixed in dollar terms.In addition to these more direct forward and backward linkages within the domestic economy, there are important inter dependencies between the monetary policies of different countries. These also represent indirect linkages between a domestic macroeconomy and agriculture. Monetary linkages between nations have important implications for exchange rates and worldwide recessions. For example, as U. S. monetary policy change? responses in the rest of the world affect to some degree foreign economies, exchange rates, and prices which, in turn, translate into shifts in the export demand facing domestic farmers. Under fixed exchange rate regimes, such as the monetary system set up by the Bretton Woods agreement, central banks are compelled to intervene to maintain a fixed value of their domestic currency vis-a-vis foreign currencies. With flexible rates, no such intervention is necessary. fuile monetary authorities may still intervene from time to time in foreign exchange markets, such actions have become discretionary. Under fixed exchange rates, expansionary monetary policies in one country cause similar expansionary policies in others as they observe their currencies appreciating. The country beginning the expansionary process is said to have “exported” its inflation. When exchange rates are flexible, no obligation exists to maintain exchange rates by domestic inflation. Only if nations keep rates within a certain range in a ”managed float” can inflation be exported. MCKinnon and others have emphasized in recent years that the argument for monetary independence between nations under flexible exchange rates involves an untested assumption about the portfolios of money holders. A monetarily independent country must be an “insular” economy, at least as far as money demand is concerned. Money holders must not substitute for foreign currency holdings’ when the domestic currency becomes less desirable, nor vice versa. If this is not true, currency substitution implies that the effects of domestic monetary policy are exported even under perfectly flexible rates. This exporting of monetary policy and the resulting loss of independence can occur in two ways. First, when there is substitution between currencies, money growth rates are conditional on expected money’ growth abroad. For example, suppose the United States engages in some unanticipated monetary policy, say, expansion. There will be an increase in the demand for the foreign currency, if domestic expansionary policies are expected to depreciate the value of the dollar.