Abstract
This paper addresses to what extent governments have traded off price distortions for reduced volatility in intervening in agricultural and food markets during the recent food price spikes. We develop a model to derive how much distortions a government would introduce when it cares about stability in a situation with limited policy options. We show a trade-off and identify the optimal combination of distortions and stability for given international price shocks and interest groups preferences for stability. Empirical evidence shows that several countries have been able to reduce (short run) price volatility in the domestic markets while at the same time allowing structural (medium and long term) price changes to pass through to producers and consumers. However, this is not the general case. For many countries, even when explicitly taking into account the trade-off (and the benefits of reducing volatility) government policies appear far removed from the optimal trade-off and there appears to be much room for policy improvement.
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