Accordingly, foreign monetary authorities will underestimate their own money demands, and their policy will turn out to be more restrictive than desired. Foreign monetary independence from U. S. policies is lost. A second possibility is that foreign authorities recognize unanticipated shifts in U. S. monetary policy quickly. They may act to maintain the value of their currencies rather than allow them to appreciate. They accommodate the U. S. money growth by responding with the same policy. Money is no longer as tight in the rest of the world, but the result is an even greater increase in the world money supply. This is exactly the phenomenon McKinnon has claimed was responsible for the rapid worldwide inflation of the 1970s. As foreign monetary policy is more or less restrictive than originally intended, without monetary independence agricultural exports either fall or rise. The magnitude of changes in foreign income effects, and the resulting changes in export demand, will depend on the failure abroad to anticipate changes in domestic monetary policy. As long as money growth is not perfectly anticipated,raspberries in pots there will be real effects on income and other variables.
The changes in domestic money growth rates can be thought of as sterilizing the effects of unanticipated money shocks abroad. In this context, it is important to clarify the conventional view of the sterilization of reserve flows. The usual interpretation involves a central bank intervening in currency markets to prevent its currency from, for example, depreciation. Since this involves buying its currency with bonds or foreign exchange, there is a reduction in the money stock. Sterilization would involve an offsetting expansion of domestic money so as to maintain previous money growth targets. There is no clear reason, however, for such an operation. As long as capital is mobile, the sterilization operation will indeed leave the total money stock unchanged; but the situation of excess currency supply, pressuring a depreciation, is also unchanged. It will, therefore, be necessary to adjust monetary growth to accommodate, or sterilize, unanticipated changes in money demand. To the extent that monetary authorities are able to make this adjustment, and to the extent that money holders do not perceive this as a shift in policy , there will be no real effects on economic activity. More likely, however, there will be shocks in real variables, such as income and the real rate of interest, as unanticipated money growth is discovered by money holders.
The importance of the disincentives typically inflicted upon agriculture by LDCs can be best dramatized when those disincentives are removed. The reforms in the People’s Republic of China provide the clearest example of what happens when policies become more market oriented. After two decades of sluggish growth, Chinese agricultural output soared after 1978 when regulations were liberalized and prices were allowed to rise and approach market-determined levels. This remarkable expansion, making China now the largest wheat producer in the world, was achieved almost entirely through productivity gains. The amount of land under cultivation and the use of tractors for farming declined between 1978 and 1983–the major change was clearly to the incentive system. Some observers have argued that such policy changes lead to reduced export demand for agricultural products from the developed economies of the world. This is not necessarily the case. By fueling domestic growth and increasing rural income, many of these countries become better customers for some agricultural products for which only developed nations can provide. Studies have shown that the “crowding out” of U. S. agriculture by expanding developing country production are exaggerated. Thus, there may be a basis for cooperation in agricultural trade reform between developed and developing nations. Nations that have not liberalized their agricultural policies, particularly those in Africa, have suffered from food shortages, and even widespread malnutrition and famine. When the enormous surpluses of the developed economies are juxtaposed with the situation of poorer developing countries, the world agricultural imbalance seems particularly galling.
The problem is not one of agricultural supply, however, but one of allocation and distribution. The poorer countries are not poor because they need more agricultural production but because they lack the income to buy more food on world markets. By liberalizing their agricultural policies and allowing market incentives to spur their farmers, poorer LDCs can not only increase domestic production in products for which they have comparative advantage, but they can increase rural incomes so they may trade for the essential foodstuffs. OUr particular concern here, however, is not with the internal policies of LDCs but with the links between industrialized country policies and economic conditions in the developing world. Monetary and fiscal pOlicies, distortionary agricultural policies, and other macroeconomic policies in the developed world affect general economic conditions in LDCs. The implications of these policies for a specific nation depend largely on its internal economic structure. Essentially, industrial country policies can affect an LDC, especially a commodity-exporting LDC, through real rate of interest, the terms of trade, and the stocks of primary products. The effect of these forces will vary with the degree of openness in a particular LDC’s trade structure and its level of initial indebtedness.Macroeconomic policies also affect the level of trade and the competitive advantage of other countries. The major macroeconomic variables are income growth rates, real interest rates, and exchange rates, with the rate of income growth being the most important of these three. Most notably, the income growth of OECD countries is crucial to the growth of world trade in general and of LDC exports in particular.
World demand for typical LDC goods is particularly procyclical, explaining why exports of such goods fell sharply from 1980 to 1982 after the rapid growth in the 1970s. LpG export volumes responded well to the U. S. recovery that began in 1983 and spread weakly to other industrialized countries in 1984. Prices of LDC exports, however, which began to fall during the recession, continued a downward trend through 1985. This was true whether measured in terms of dollars or in terms of LDC import prices. In part because of high real-interest rates, prices of LDC exports, particularly of commodities, have remained depressed throughout the 1980s. The increase in world interest rates,blueberries in containers growing in the early 1980s was primarily the result of U. S. monetary and fiscal policies. This increase has had three major effects on commodity-exporting LDCs. The first effect has been a depressing effect on the price of commodity exports. Since storable commodities are viewed as a portfolio asset, real interest rates will represent the opportunity cost of holding a commodity and will affect the demand for storage.Consequently, the relative price of commodities will decline until the expected rate of change in the product’s value is equated with the real interest rate. The second effect has been an increase in the debt-service burden of the debtors. An estimated 80 percent of all major LDC debt is under variable rate agreements. As real interest rates crept upward in the early 1980s, so did the interest payments portions of their debt service. Additional principal also accumulated with the occurrence of current account deficits due to falling exports receipts .l A debtor carries an additional burden when the value of the debt is fixed in one currency, and the export receipts are valued in another. When the debt currency appreciates relative to the export currency, the value of the LOCs’ external liabilities rises. This was a common occurrence with the huge dollar appreciation in the 1980s. Finally, higher interest rates can also affect internal economic performance by reducing investment in favor of increased saving. Capital flows to countries with higher real rates, and it is not uncommon for real differentials to exist between the developing countries and the United States due to regulated financial markets in the LDCs. Although not easily quantifiable, this channeling of savings may have important consequences for future LDC debt prospects as the stock of capital goods dwindles and with it future production possibilities. This was as important as the loss of export revenue during the early 1980s in the creation of increases in the current account deficit, the external debt, and the debt/export ratio.
The third and final effect of higher world-interest rates is the direct effect on interest rates within each LDC because of arbitrage opportunities. For many LDCs, the magnitude of capital flows in response to interest rate differentials helps explain why local LDC interest rates eventually must adjust. Another major variable, the exchange rate, is influenced not so much by the level of macroeconomic policies but by the differences between macroeconomic policies in the United States and other countries. Although the influence of exchange rate on agricultural trade is indeed complex, a number of direct effects have been captured empirically . These include price effects, cross-price effects associated with sub-stitutable commodities, and policy-distortion effects. If the value of the dollar were to increase by 10 percent, it would make very little difference to the importers of corn in Japan if the price of corn were to fall by an equivalent amount because the net cost in Japanese yen to an importer would remain the same. In the early 1980s, however, with a rapid increase in the value of the dollar, a corresponding ‘fall in the price of U. S. corn was not possible. U. S. support prices were simply too high, and there occurred a so-called policy distortion effect. When the price of corn from other origins is downwardly flexible and currency is arbitraged, the export demand naturally falls for corrunodities with “high” price supports. There are a number of secondary, or indirect, effects of exchange rates that exert influence on agricultural trade. Indirect influences on income and growth affect export demand. One of these indirect effects is from foreign central banks’ systematic intervention in exchange rate markets to influence the value of their currency. When such intervention is not sterilized, it changes money supplies of the intervening countries and, in the short run, also changes the rates of income growth. Another effect is when a change intrade balance due to movements in the exchange rate increases growth in income, a part of which is spent on imports. A third, indirect effect is from wealth transfers associated with current account imbalances. Current flow payments are equivalent to wealth transfers, and such transfers require movement in interest rates to restore equilibrium in money markets. A new equilibrium causes changes in investment income and in export demand for agricultural products. In addition to all of the above effects of exchange rates, there can be additional effects on the debt/export ratio if the currency composition of the denomination of debt differs from the currency composition of the exports. For example, many debtor countries suffered from the sharp appreciation of the dollar when their debts were in dollars, while their exports were in other currencies as well. This phenomenon occurred regardless of whether or not a shift occurred in a debtor country’s terms of trade during the 1980s. For this reason, the dollar’s appreciation has often been listed as one of the three macroeconomic shocks, along with the recession and the increase in real interest rates, that helped precipitate the debt crisis of 1982. The shift to a more restrictive monetary policy and the unprecedented expansion of the fiscal deficit in the early1980s pushed up real ;interest rates both in the United States and abroad. This rise in rates of return directly enlarged the LDC debt service obligations and indirectly drove down commodity prices via overshooting and dollar appreciation. Expansionary fiscal policy can, however, also increase demand for LDC agricultural goods, thereby, producing an offsetting effect on the terms of trade.Because of inadequate domestic savingst current and foreseeable budget deficits will continue to be a major force behind the United States’ large existing trade imbalances. The so-called twin-deficits problem will continue plaguing the export performance of U. S. agriculture. Few policymakers realize that the large budget outlays for farm policy are partially responsible for the dismal trade performance of the sector. The causal flow moves from subsidization of agriculture t to government budget deficitst to the need of foreign countries to generate trade surpluses that will finance their capital flows into the United States. The latter capital flows finance U. S. credit demands.