Price Stability

1. Price Stability Econ 4300 2008

2. Price Stability Read Chapter 7 of Schmitz, Furtan and Baylis “Agricultural Policy, Agribusiness, and Rent-Seeking Behaviour”

3. Stability • Policy objective is price and income stability • What is stability? • Constant over time • Increasing over time

4. Price Stability • Buffer stocks • Store commodity when prices low, release into the market when prices high • Needs to be a storable commodity • Storage costs can not be high

5. Price Stability • Do producers and consumers really what stable prices? • Has been shown that under certain conditions, consumers prefer variable prices • Similarly for producers • However, when both considered, stable prices result in higher social welfare

6. Income Stability • Price stability can reduce income stability • Demand and supply not perfectly elastic • When supply less, the lower sales are off-set by higher prices • When supply high, the higher sales are off-set by lower prices • A role for private storage to buy commodity when price is low and sell when high

7. Middle-Man Market Power • A pure monopoly can gain from storing a commodity • With monopoly, price to consumers higher than perfect competition • Price to consumers constant over time • Price to producers lower than under perfect competition • Price to producers varies with supply

8. Middle-Man Market Power • Agriculture – difficult to prove • Processors – not in storage business, storage costs could be high • Grain dealers – with only 3 or 4 major world players, they are often suspected of MP

9. Price Expectations • Price forecasts • Naïve: E(Pt+1)=Pt • Adaptive: E(Pt+1)=Pt + γ[Pt – E(Pt)] • Rational Expectations: • Use all current and past information (It) • Pt = Et(Et+1 | It) • What info? PROs, WCE, Minneapolis, El Nino, La Nina, contracts, weather forecasts, …

10. Risk and Producer Uncertainty • Models generally assume risk neutral • Producers are typically risk averse • If risk is reduced, through gov’t programs for example, supply will increase • Increased supply -> lower prices • If a gov’t program, does it fit within the WTO?

11. Farm Sector Stabilization • Why for governments attempt stabilization? • Economic • If highly variable prices and producers are risk averse, output will be less than socially optimal • Producers make fewer long-term investments, reducing production in the long-term • Political

12. Causes of Price Variability • Excess demand shifts • Droughts/surpluses in importing countries • Excess supply shifts • Crop failure/bumper crop in exporting country • Government intervention • Export subsidies, macro policies • Other • Elasticity of excess demand and supply

13. Stabilization • Can prices be stabilized? • Conditions that exist – price trends • Stability vs. income support • Causes of stabilization program failure • Income uncertainty and inability to project • Declining incomes • Political uncertainty

14. Canadian Support Programs Agricultural Stabilization Act (1958) • Guaranteed 90% of 3-yr moving average price • Fed funded • Payouts small until 1974 • In 1976, grains removed • Payments ‘exploded’ in 1980’s • Program ended in 1991

15. Canadian Support Programs Western Grain Stabilization Act (WGSA) • Stabilize crop income • To replace ad hoc policies • Gov’t and producer funded • Prices declining but production increasing, so incomes did not decline to trigger payments • By the late 1980’s, the WGSA was insolvent

16. WGSA impacts • Reduced price variability • Increased supply • Raised producer incomes • Payouts in 1977, 1978 (small) • Payouts in 1987 to 1991 (huge)

17. Canadian Support Programs Special Grains Program • Payment due to low grain prices, 1986, 1987 • $1 billion each year • One-time special payment

18. Canadian Support Programs Tripartite Stabilization • Developed for non-grain • Fed., Prov. and producer contributions • Similar impacts to WGSA • Countervailing tariff actions by United States (especially red meats) • Programs discontinued by 1994

19. Canadian Support Programs Farm Income Protection Act (1991) • A) GRIP – gross revenue insurance • B) NISA – net income stabilization • C) crop insurance

20. Canadian Support Programs GRIP • Guaranteed gross revenue per acre • Sask. withdrew from program after 18 months, too expensive

21. Canadian Support Programs NISA • Fed., (later Prov.), and producer funded • Individual funds (Fund 1 gov’t money and taxable when withdrawn, fund 2 producer’s money and not taxable) • Funds can not go into deficit • Concerns – timing of payments, declining incomes, ‘savings’ accounts,

22. Canadian Support Programs Agricultural Income Disaster Assistance • 1998 temporary • Designed with WTO rules • Payment if net income < 70% of moving avg. • Costly administration (producers and likely government) • Discouraged diversification

23. Canadian Support Programs Canadian Agricultural Income Stabilization (CAIS) • Replaced NISA • Based on production and reference margins • Inventory adjustments • Producer contributions initially required, then dropped • Replaced in 2007

24. Canadian Support Programs AgriStability (AS) and AgriInvest (AI) • AS – payment if current year margin falls below 85% of reference margin • AI – producer and government contributions deposited in an AgriInvest account

25. Canadian Support Programs Provincial Programs • Most provinces have ended their own programs and joined the federal programs. Provincial funding part of these programs.