Overshooting Agricultural Commodity Markets and Public Policy: Discussion

The premise of this session, that monetary, fiscal, and other macroeconomic policies are now as important for U.S. agriculture as price support and other sector-specific microeconomic policies, is gaining widespread acceptance. These two papers, though very different in size and scope, are both welcome contributions. Let us begin by considering the frictionless competitive world that the Andrews-Rausser (AR) paper calls the new classical paradigm and that the Rausser, Chalfant, Love, and Stamoulis (henceforth RCLS) paper calls the monetarist-neoclassical model. Such a model has two very strong implications for agriculture. First, macroeconomic policy has no systematic effect on real commodity prices, only on nominal prices. Second, there is no welfare justification for government intervention to help the farm sector. (Like RCLS, I am abstracting from nonmarket considerations like income distribution.) It is more clear in the 1980s than previously that we do not live in such a world. Although prices of agricultural commodities are determined flexibly (in the absence of government intervention), prices of most goods and services in the Consumer Price Index (CPI) are sticky. For example, when the nominal money supply falls by one percent, the CPI is not free to fall proportionately, with the result that the real money supply falls as well. The result is large effects, at least in the short run, on real interest rates and real exchange rates. Real commodity prices are in turn sensitive to real interest rates and real exchange rates. How can we be so sure that the sticky-price view of the world is more accurate than the frictionless one? Of the many possible pieces of evidence, I offer four here, one for each of the speakers in this session. First, the AR paper shows in table 1 that in the big cyclical downturns of the early 1930s and the early 1980s, prices fell more (and quantities fell less) in the agricultural sector than in any of nine other sectors. Second, the RCLS paper reports the finding that in regression equations for a farm price index, the money supply showed up as a relatively more important determinant and the lagged endogenous variable as less important, compared to regression equations for the CPI. Third, Cumby and Obstfeld, among others, have shown clearly that real interest rates vary significantly across countries, which refutes the old view that real interest rates are constant. The finding is undoubtedly related to the well-known finding that purchasing power parity does not hold, even approximately: exchange rate changes do not match changes in relative price levels. A fourth piece of evidence comes from observed market reactions to the Federal Reserve's weekly money announcements. When the money supply turns out to be greater than expected, nominal interest rates tend to rise and prices of wheat, corn, and other basic commodities tend to fall. If the frictionless view were correct, then interest rates and commodity prices should either both rise (if the announcement causes the public to revise upward its expectations of future money growth) or else both fall (if the public revises downward its expectations of future money growth). The only hypothesis that explains the reactions in both the interest rate and commodity markets is that the increase in the nominal interest rate is also an increase in the real interest rate (presumably because the public anticipates the Fed will reverse the recent fluctuation in the money stock), which depresses the real prices of commodities. Thus, the classical grounds for automatically prescribing laissez-faire are rejected. But this conclusion must not become an excuse for the government to intervene blindly in agricultural markets. The authors of both papers recognize that the policies that are actually adopted in practice are seldom well designed Jeffrey A. Frankel is an associate professor of economics at the University of California, Berkeley, and a research associate at the National Bureau of Economic Research.