Monetary policy, exchange rate, and effects on US wheat trade and domestic market in an imperfect competition framework

Abstract

Since the agricultural commodity boom and the two concurrent devaluations of the U.S. dollar in the early 1970s, the effect of exchange rate change on agricultural trade has been extensively studied. Change in exchange rate regime from fixed to flexible in 1973 coupled with the farm crisis in the early 1980s directed attention of study to the assessment of impact of monetary policy on agriculture. However, the theoretical and empirical conclusions of the effect of exchange rate or monetary policy are mixed so far. The primary reasons of these mixed conclusions might be because of the use of the conventional competitive framework and the weak linkage between agricultural and financial market;This study develops a new U.S. wheat model that consists of wheat trade in the imperfect competition world market and competitive domestic market, and then uses the model to measure the impacts of monetary policy on wheat trade and domestic market. The duopoly characteristic was adopted for the world wheat market. Such incorporation made this model different from the conventional competitive framework. The complete U.S. wheat model was constructed by combining the duopolistic trade and competitive domestic market together. For the assessment of the impacts of monetary policy, the U.S. wheat model was connected with the financial market via linkages of exchange rate and interest rate determination. These two rates were endogenized and the portfolio equilibrium model was employed to determine these two rates;The model was empirically estimated using annual data for the period 1965 to 1985. The estimation technique was nonlinear, three-stage least squares. Almost all estimated coefficients were highly significant and all had correct signs as theoretical expectations. All statistics of model examination indicated that this model performed satisfactorily. Using this model, the impacts of monetary policy were analyzed for the period 1973 to 1985 using dynamic simulation and multiplier analysis;The empirical results indicate that the U.S. wheat industry faces two almost equally important markets which have different characteristics, and the associated determination process of the domestic and export prices is different. The effect of monetary policy on export price is dramatically elastic, but on quantity exported is quite small. In the domestic market, the effect on commercial ending stock is elastic, however, on the domestic disappearance and the domestic price are inelastic. Since U.S. wheat sector is heavily dependent on exports, an expansionary monetary policy would tend to have a positive impact on the sector.