Transcript Objectives today - Economics of Agricultural Development

Macroeconomic Policies
AAEC 3204
Dr. George Norton
Agricultural and
Applied Economics
Virginia Tech
Copyright 2009
Objectives
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Discuss influences of fiscal and
monetary policies on agriculture
Discuss effects of key macro-prices
on agriculture
Why governments pursue particular
macroeconomic policies
Demand Description
Supply Description Income Description
Consumption
Agricultural production
Wages
+
Private investment
+
+
Industrial production
Interest
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Government expenditures
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+
Production of services
Rents
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Excess of exports over imports
Government production
Profits
Gross Domestic
Product (GDP)
Gross Domestic
Product (GDP)
Gross Domestic Product (GDP)
+
Net income transfers abroad
Gross National Product (GNP)
Three descriptions of a
macroeconomy.
Why do governments pursue
particular macroeconomic policies?
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Distribute income in a particular way
(political expediency)
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Correct past problems (i.e. pay off debts)
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Keep inflation down (budget problem)
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Stimulate growth in economy (often short
run) or in a sector (provide incentives)
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React to changing world conditions
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Corruption
Fiscal and Monetary Policy
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Fiscal Policy – relates to
government spending and taxing
Developing countries often go in debt
because of many pressing needs and
limited tax revenue
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Monetary Policy – Relates to
government monetary supply and
interest rate policy
Monetary Policy
Can finance deficits through:
(a) increasing money supply
(printing money) or (b) borrowing
from abroad
What are the effects?
Y=PxQ=C+I+G+X-M
Y = money value of output or income
P = price index of all goods and services
Q = quantity index of all goods and services
C = consumption expenditures (private)
I = investment expenditures (private)
G = government expenditures
X = value of exports
M = value of imports
Assume country has a deficit
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If financed by printing money, G
Q can rise to meet this if resources
are idle
If shortage of capital or land, either
M must go up or P must go up
If P up, this means inflation
Inflation can also result if import
prices are rising
Connections between macro policy and food
policy
Macroeconomic policy
Fiscal and monetary policy
Budgetary policy
Macroprice policy
Inflation
Exchange rate
Food programs
Producers
Interest rate
Agricultural price
policy
Rural-urban terms
of trade
Consumers
Trade policy
Agricultural policy
Wage rate
Governments use macro prices to affect inflation,
provide incentives, and distribute income
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Foreign exchange
rates
Interest rates
Wage rates
Land prices
Prices for agr.
Versus industrial
goods
Government can
try to set these
Affected
indirectly by
government
policies
Exchange Rates
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What are they?
How do they become overvalued?
What are the effects of an
overvalued exchange rate?
Foreign Exchange Rates
Value of a nation’s currency relative to value
of the currency of another country
Exchange rates in developed countries
determined in international currency
markets
Exchange rates in developing countries
often set by government and “pegged” to
currency of a major developed country
Many developing countries
overvalue their currency
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Why?
• Keep downward pressure on prices
• Fixed against another country’s
currency to stabilize price of goods
traded with that country
Purchasing Power Parity Theory
 P1t
rt  r0  
 P2t



rt = exchange rate between 2 countries
at time t
r0 = exchange rate in base period
P = general price level in country 1, 2
P1t/P2t = measure of differential rates of
inflation (if rates of inflation from 0 to t
are the same then P1t/P2t = 1)
r  P  P2
*
rate of change
in the exchange
rate
*
1
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difference in
rates of inflation
Therefore: P  r  P
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1
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So country tries
to manipulate r*
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2
What are the Effects of an
Overvalued Exchange Rate?
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Raises price of exports and reduces
price of imports
Temporarily can keep inflation down
Creates balance of payments
problem
FIXED Versus FLEXIBLE
Exchange Rates
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Why do countries choose one
exchange rate regime or another?
How do exchange rates become
over-valued?
Interest Rates
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Role
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High versus low
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Difference between
nominal and real
rates
Wage Rates and Land Prices
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Wage rates
• How are they determined?
• Effects of minimum wage legislation?
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Land prices
• How do macro policies affect?
Rural – Urban Terms of Trade
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Relative output and input prices in
rural compared to urban sector
How affected by exchange rate and
by fiscal and monetary policies?
Rural – urban price differences
influence rural – urban income
differences
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Interest rates,
Capital movements,
Exchange rates,
Trade, and
Inflation are
interconnected
How?
International Interactions
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Example:
• Interest rates up attracts capital from
abroad
• Capital inflow drives up exchange rate
• Higher exchange rate reduces demand
for exports and increases supply of
imports
• Exports down and imports up mean
more goods at home
• More goods on the market compared to
demand keeps inflation down
Low U.S. interest rates have contributed
to recent dollar weakness
Difference between U.S. and Euro 6-month interbank rate, €/$ exchange rate
€/$
1.6
Percent
3.5
Interest rate spread
3
1.4
2.5
Euro / $
1.2
2
1.5
1.0
1
0.5
0.8
0
0.6
-0.5
0.4
-1
0.2
1995
-2
-1.5
1996
1997
Source: World Bank
1998
1999
2000
2001
2002
2003
2004
2005
World Macroeconomic
Relationships
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Bloc – floating exchange rates
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Integrated world capital markets
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Cross – country effects of monetary
and fiscal policies
Changes in comparative advantage
and competitive advantage
Long-term Debt and short-term
financial crises
Conclusion
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Macroeconomic policies and prices
have as large an effect on
agricultural prices as do agricultural
sector policies