The devaluing pressure on the exchange rate would create an interest differential in favor of the foreign countries and a capital outflow which would increase the depreciating pressure on the exchange rate. Money supply growth would thus decrease proportionally and so would price inflation, at least initially. Real depreciation would then lead to an increase in demand . The increasing output demand would raise inflation, and thus real money balances would start to fall. Nominal interest rates would then increase, thereby restoring the capital account. Ultimately, real depreciation of the exchange rate and falling real money balances would bring the system back to equilibrium. With government intervention in agriculture, the government is able to “neutralize” any effect of foreign disturbances on domestic prices and demand. That is, the government can fix the target price at the existing domestic price level, allowing domestic producers to sell on the domestic market at the world price, with the latter below the former, and paying the difference. This kind of intervention amounts to a complete “sterilization” of foreign disturbances on the trade balance,plastic gutter the exchange rate, and on monetary growth and domestic inflation.
In the long run, this strategy would lead to unsustainable cumulative budget deficits; if the foreign price decrease is penn anent, an increase in domestic taxes is then necessary in order to finance the deficit. This, however, would lead to a decrease in disposable income with the consequent deflationary effects. Therefore, we define an intervention mechanism that allows zero-sum deficits in the long run. We will assume all non-farm government expenses are exactly balanced by tax revenues so that all government spending in agriculture amounts to a deficit in its budget. The resulting budget deficit must be either monetized or debt financed. Both operations have obvious effects on the money market, the capital account, and the trade balance. Increases in government expenditures which are debt-financed directly increase domestic absorption and income but do not have any effect on the monetary base. Increases in government expenditure financed by money creation directly increase domestic absorption and income and obviously affect money supply. In the fonner case, the overall long-run effect depends on the degree of capital mobility and be either contractionary or expansionary. In the latter case there are no real long-run effects. Without ruling out any of the two possibilities, the budget deficit is specified to be debt financed and partly monetized. The introduction of government expenditure in agriculture has several implications. First, the real effects of changes in money and in the exchange rate appear to be dampened. This accounts for the sluggishness of movements in prices, output, and the trade balance that occur because of “institutional” factors.
In particular, by acting on the way agricultural output reacts to changes in the monetary variables, the standard model is modified and all price deflationary or inflationary effects are lessened. Under this new framework, money is still neutral in the long run; but it has non-neutral effects in the short run which are smaller than in the standard model, and the overshooting in the exchange rate is smaller as well. Second, the entire dynamics of fann prices is altered. In the standard model, the differences in the dynamics of the two prices are ultimately due to their different degrees of stickiness and to the overall GNP share of the two sectors. These differences can, for instance, put the fann sector in a “cost-price” squeeze if manufacturing prices increase more than fann prices in the short run. With government intervention, farm prices are more protected; and if the degree of intervention is high, the overall real effect on farm prices of monetary contractions or of exchange rate appreciations can be nil, and thus the differential speed effect can turn in favor of fann prices. Third, several feedback effects other than the ones already present in the standard model can occur in the new fonnulation. Since the main scope of government intervention is to counter unfavorable movements in relative prices and to dampen the negative effects of monetary shocks on the fann sector, the impact on the money market and on the entire economy resulting from the financing of the budget deficit now represents one more channel of feedback from prices to money and the exchange rate. In order to introduce explicitly government intervention in agriculture, we assume that agricultural producers have a notional supply function of the type defined by Barro and Grossman .
This supply function depends mainly on two types of forces: a combination of policy indicator variables and excess demand pressures. The policy indicator variables represented here are target price, q, and a land reduction premium , v. Regardless of the market prices, agents who participate in government programs are assured a certain price of q. The second policy indicator serves to lessen the financial burden of accumulating stocks resulting from target prices well above market prices, e.g., under current legislation, an acreage reduction program is employed to assist in reducing producers’ supply.! The coefficients and c:o measure the weight that producers attach to the two arguments in the supply function. If ro is close to one, agricultural output is essentially demand determined. Alternatively, if c:o is close to zero, supply would be essentially determined by policy variables and relative prices. In a competitive world , if foreign prices fall below a certain level, then domestic producers will be paid the price given by q fixed at that level . The difference between the target price, q, and the world price, e + P:, is paid to domestic producers by the government. Target prices set above market prices create excess supply and large government expenditures to finance the implied level of subsidy. In order to reduce wide excess supply accumulations from target price incentives, the government affects producers’ decisions through the acreage reduction program. The higher stock accumulation,blueberry container the stronger will be the action of the government to reduce output supply. Although inventories are exogenous in our framework, it is clear that it is the interaction between the inventories and production costs on one side and between the inventories and interest rates on the other that plays a major role in determining the amount of acreage reduction intervention in agriculture. Given no trade barriers, an exogenous reduction in the foreign price of agricultural products would result in a shift of internal demand from domestic to foreign goods; a trade balance; and, thus, depreciating pressure in the exchange rate. With no intervention policy in agriculture, the monetary authority would then intervene by contracting the supply of domestic money on the world market. The pressure on the exchange rate would create an interest differential in favor of the foreign countries and a capital outflow which would increase the pressure on the exchange rate. Money supply growth would thus decrease proportionately, as would price inflation . Real depreciation would lead to an increase in demand . The increasing output demand would raise inflation, and thus real money balances would start to fall. Nominal interest rate would then increase, thus restoring the capital account. Ultimately, real depreciation of the exchange rate and falling real money balances would bring the system back to equilibrium. With government intervention in agriculture, we can have a quite different scenario. Suppose that, in the extreme case, the government wants to neutralize any effect of foreign disturbances on domestic prices and demand. That is, suppose the government fixes the target price, q, at the existing level, PA, and allows domestic producers to sell on the domestic market at the world price, e+ P:, where e+ P: < PA and pays them the difference .
This kind of intervention amounts to a complete “sterilization” of foreign disturbances on the trade balance, the exchange rate, and on monetary growth and domestic inflation. However, this could not last forever since, in the long run, this would lead to unsustainable cumulative budget deficits. If the foreign price decrease is permanent, an increase in domestic taxes would then be necessary in order to finance the deficit, but would lead to a decrease in disposable income with the consequent deflationary effects. Therefore, we need to define an intervention mechanism that would allow zero-sum deficits in the long run. These equalities highlight the relationships among the farm policy instruments. The two types of intervention can be interpreted as follows: The rate of increase in government financed price-target programs is guided by a rule that relates to the excess of the domestic price increase over the increase of the exchange rate. The higher the “support” coefficient, the higher the response in the rate of growth of government expenditure in price target programs. Hence, in the limit, as gl tends to infinity, the rate of increase in domestic agricultural prices is kept equal to the rate of depreciation. In the above case, the rate of increase of relative prices would be basically zero. What such an intervention rule shows is that the higher government support is, the lower will be the gains in competitiveness due to movement in the exchange rate and/or in foreign prices. However, although temporary shifts in competitiveness are minimized, the negative effects of the increase in the government expenditure for agriculture will have impacts on the government budget deficit and, ultimately, on the money market. On the other hand, the rate of increase in government-financed supply-reduction programs is guided by a rule that relates it to the excess of money supply growth over farm price inflation. The higher the intervention coefficient, g2′ the higher the response of government expenditure in supply-reduction programs. In the limit, all excess supply is “absorbed” by government intervention so that, ultimately, any excess supply is eliminated and the price growth rate is kept equal to the money supply growth rate. This amounts to assuming, in the limit, that agriculture supply is kept at the market-clearing level. It is clear, however, that even in this case all the budget effects of the supply-reduction programs will have an impact on the money market, depending on the magnitude of the intervention coefficients. It affects only investment and savings if the increased spending is financed by the sale of government bonds. The sale of bonds does not affect the domestic money supply since the funds obtained by the government from the bond sale returns to the public as the government spends it. Thus, the LM curve is not directly affected by the changes in government debt financed spending. Of course, if the increase in government expenditure is financed by the issuance of money, then both aggregate demand and demand for money will be affected. Increases in government expenditure which are debt financed directly increase domestic absorption and income but do not have effects on the monetary base. However, the increase in income heightens the demand for money, driving interest rates up. At the same time, all else constant, the increase has a negative impact on the trade balance, raising the demand for imports. The rise in the interest rates attracts capitals from abroad, restoring the capital account and counterbalancing the current account. Whether the balance of payments will be in surplus or in deficit will depend ultimately on the degree of capital mobility, the magnitude of the income multiplier, the willingness to save, and the propensity to import. If capital mobility is low, an increase in government expenditure has a negative effect on the balance of payments. Money supply decreases over time, due to the decumulation of international reserves, inducing income to decrease and partially offsetting the initial expansionary effect. If capital mobility is high, a balance of payment surplus will arise and money supply will increase, generating an additional income expansion over time. Increases in government expenditure financed by money creation directly increase domestic absorption and income and also affect money supply. The income effect generates a trade balance deficit through the increased demand for imports. The excess supply of money will be spent on foreign goods and also on foreign assets, thereby generating a capital account deficit. Complete adjustment will occur over time by means of net purchases of foreign goods. This slow adjustment will be reflected by trade deficits. In essence, the increase in the money supply through the printing of money will induce both the balance of trade and the balance of payments to worsen over the short run.