Price Stability
Econ 4300
2008
Price Stability
Read Chapter 7 of Schmitz, Furtan
and Baylis “Agricultural Policy,
Agribusiness, and Rent-Seeking
Behaviour”
Stability
• Policy objective is price and income
stability
– What is stability?
• Constant over time
• Increasing over time
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
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
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
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
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
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, …
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?
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
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
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
Canadian Support Programs
Agricultural Stabilization Act (1958)
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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
Canadian Support Programs
Western Grain Stabilization Act (WGSA)
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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
WGSA impacts
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Reduced price variability
Increased supply
Raised producer incomes
Payouts in 1977, 1978 (small)
Payouts in 1987 to 1991 (huge)
Canadian Support Programs
Special Grains Program
– Payment due to low grain prices, 1986, 1987
– $1 billion each year
– One-time special payment
Canadian Support Programs
Tripartite Stabilization
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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
Canadian Support Programs
Farm Income Protection Act (1991)
– A) GRIP – gross revenue insurance
– B) NISA – net income stabilization
– C) crop insurance
Canadian Support Programs
GRIP
– Guaranteed gross revenue per acre
– Sask. withdrew from program after 18 months,
too expensive
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,
Canadian Support Programs
Agricultural Income Disaster Assistance
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1998 temporary
Designed with WTO rules
Payment if net income < 70% of moving avg.
Costly administration (producers and likely
government)
– Discouraged diversification
Canadian Support Programs
Canadian Agricultural Income Stabilization
(CAIS)
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Replaced NISA
Based on production and reference margins
Inventory adjustments
Producer contributions initially required, then
dropped
– Replaced in 2007
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
Canadian Support Programs
Provincial Programs
– Most provinces have ended their own programs
and joined the federal programs. Provincial
funding part of these programs.