Relative Price Dynamics and Monetary Policy: Evidence from Directed Graphs

Abstract

The nature of the dynamic linkages between monetary policy and the agricultural sector has been one of the most debated in the recent past, yet with little consensus. Central to this debate is the question of whether the responses of agricultural prices to monetary policy shocks differ from the responses of prices in the rest of the economy. This question is important given the increasing dependence of agriculture on international markets and the potential impacts of changes in macroeconomic variables such as interest rates, exchange rates, and foreign income growth patterns. The importance of macroeconomic policy linkages to agriculture and trade is further emphasized by the reduction in foreign demand for U.S farm exports in the aftermath of the recent Asian financial crisis. Although most theoretical models advocate money neutrality (i.e. money does not affect prices) in the long, Bordo’s work showed that changes in the money supply can induce changes in the relative prices in the short-run. Currently there are several alternative approaches used by researchers to evaluate the timing and magnitude of macroeconomic policy variables on agriculture. On the one hand, there are models based on Granger’s approach to testing for causality. Within this scheme, F-tests could be used to infer the direction of causality between U.S. money supply and agricultural prices (Barnett, Bessler, and Thompson; Lapp). On the other hand, the approach favored by most researchers is to use vector autoregression (VAR) or its variants (error correction and cointegration models) to identify the response of agricultural prices to changes in macroeconomic variables (Bessler; Devadoss and Meyers; Taylor and Spriggs; Orden and Fackler; Robertson and Orden; Robertson and Orden; Saghaian, Reed, and Marchant).