We performed simulations for the 1984 to 1986 period using two different assumptions concerning the level of monetization of the U.S. federal budget deficit. The deficit was set at levels projected by the Congressional Budget ,I Office for 1985 and 1986. while actual levels were used for 1984. All lagged variabIes were set at their actual levels, so the starting point reflects conditions in the U.S. during 1983. A restrictive policy regime was created by allowing the money supply to grow at the rate of trend real GNP growth; the deficit was thus entirely bond financed. An easy monetary policy regime was created by varying the level of monetization. We assumed an approximate~y 30 percent monetization, and increased bank reserves and the money supply by a corresponding amount. All other exogenous variables were held constant between the two simulations. The policy regimes of expansionary and tight monetary policy can be viewed as providing rough approximations to the environments of the early 1970s and early 1980s, respectively. Effectively. the monetary policies of the 1970s provided a subsidy to the agricultural sector. Conversely, the tight monetary policies of the 1980s can be viewed as a tax on export dependent.capital intensive sectors such as agriculture. A number of other events in the two periods. such as weather and oil-price shocks are not replicated. of course. The simulations are designed to hold other things constant and examine the effects of variations in money growth rates alone. The non-agricultural sector was modeled using the fix-price assumption. The major components of the model are domestic aggregate demand , aggregate supply represented by nonfood price and wage equations,greenhouse snap on clamp a monetary/financial sector, and a small international sector Prices and wages are assumed to adjust slowly to changes in aggregate.I. excess demand.
Prices are assumed to depend on wages adjusted for productivity. materials costs. the gap between actual and potential income. Inflationary expectations. approximated by expected money growth, also enter the price equation. Wages, in turn, depend on labor market pressure, changes in the consumer price index, and a minimum wage variable. Finally. the labor market pressure variable, the difference between actual and natural rates of unemployment, is a function of the income gap. The monetary/financial component consists of a money demand equation, a money supply process, and interest rate determination equations for short and long term rates. The model contains no unusual variables or specification in most equations. Exceptions are equations for the short term interest rate and the exchange rate. The former includes two proxy variables designed to measure capital market pressure. The first of these, representing public sector demand for credit, is the ratio of government deficits to non-borrowed reserves. The private sector proxy variable is the ratio of disposable income to non-borrowed reserves.The equation for the exchange rate is based on an asset market framework . The basic assumptions “‘Underlying this framework are rational expectations, sticky prices of goods, and uncovered interest parity. The equation expresses the natural logarithm of a trade-weighted index of exchange rates as a function of U.S. and rest-of-world money supplies, incomes, inflation rates and interest rates. In addition, a variable similar to the proxies for capital market pressure in the interest rate equation is included, the ratio of non-monetized U.S. federal deficits to non-borrowed reserves. Increases in this variable, representing increases in holdings of dollar denominated assets, lead to appreciation of the dollar. These policy settings were used to simulate behavior of interest and ,1 . exchange rates, growth in the price level, and income growth in the two monetary policy regimes, using the model outlined in the previous section.
The results were then passed to the model of the agricultural sector described in the previous section. No attempts were made with these simulations to allow feedback effects, through the deficit, for instance. from the agricultural sector to the economy at large, or through any effects of changes iri farm prices on the general price level. Table 2 shows the paths for deficits and non-borrowed reserves for the two time periods. Based on its correspondence with the 1970s, the regime of easy money is designated as the subsidy scenario, while that of tight money is termed the tax scenario. The two regimes bracket recent growth rates of the money supply, with the subsidy scenario producing approximately 18 percent money growth while the tax scenario is characterized by annual money growth at the rate of 3 percent. Thus, the two regimes are somewhat extreme compared to actual money growth rates. Table 3 reports the results from these simulations for the important macroeconomic variables which affect the agricultural sector. Real interest rates and the value of the dollar are much higher in the tight policy regime, while GNP and the price level are higher in the subsidy regime. There is both a liquidity effect and ~m. inflation premium effect in the interest rate equation due to different results for money growth between the two regimes. Real interest rates are substantially higher in the tight policy regime due to the lower level of non borrowed reserves. There is not a one-for one increase in short-run nominal interest rates following an increase in money growth rates, however. so nominal interest rates also are lower in the easier monetary policy regime. Since the focus was on quarterly movements in the variables in the agricultural sector, we have not yet tested the long-run neu trality of money growth in the model. Low real interest rates and easy money have the expected effect on real GNP in the subsidy scenario.
By the end of 12 quarters, this variable is 12.6 percent higher than in the tax scenario. Ceteris paribus, this higher income should cause the dollar to appreciate, but the effect is more than offset by the relative unattractiveness of dollar-denominated assets. The net effect of lower income growth and high real interest rates is for the dollar to appreciate during the tax scenario. Thus, the trade-weighted index of the dollar’s value is higher by more than 100 percent by the fourth quarter of 1986. Compared to 1983:4, this represents 20 percent appreciation during the tight monetary regime simulation and a near 90 percent devaluation with easy money. Finally, the effect on the price level is seen in Table 3 by the higher rate of inflation, nearly 8 percent higher by the end of the simulations. International sector variables were held constant across the two regimes. Those which enter the model are rest-of-world real GNP, indices of the rest-of world money supply and wholesale price index. and the rest-of-world produclion of wheat find feed grains. Growth rates for the 1981-1983 period were used as the basis for projecting these variables through 1986. To the extent that the world macroeconomic variables are related to those of the U.S., we have not captured what would actually happen under these two regimes. If one takes the view, for instance,snap clamp that other countries’ central banks react to U.S. monetary policy by attempting to manage the value of their currencies, it is likely that we have understated rest-of-world money growth for the easy monetary policy regime in the U.S., and vice-versa for the tight period. McKinnon’s arguments on currency substitution and world liquidity support this view. ‘While we have not run these simulations under alternative paths for rest-of-world macroeconomic variables, varying rest-of-world production of wheat does have the expected effects on demand for U.S. exports. 4 .1 Turning to the results for the agricultural sector, Table 4 gives the settings for the parameters of the wheat and feed grains programs. These policy setlings are continuations of those legislated under the 1981 Farm Bill, with 1986 levels being continuations of 1985 settings. Recently, support prices were announced for 1986 which are below those we assumed. To the extent that other 1986 conditions resemble those we simulated, one can expect higher deficiency payments and higher government expenditures on these two programs than tho~e we find in the simulation results.
We did not examine alternative agricultural policy scenarios, so it is only macroeconomic policy which varies between the two simulations. Simulations for the agricultural sector were conducted under two different government policies concerning stock holding. One simulation used an estimated behavioral equation for government stocks, which allowed market prices to fall well below support prices during the tight policy simulation. However, it seemed reasonable that participation rates for wheat and feed grains programs would approach 100 percent in such a period, especially if the policy was well anticipated. In that case, prices should not fall below the support rate, since participation carries the opportunity to sell to the government instead of the market. Thus, in a second simulation. we added an active stock policy regime by imposing a condition in our simulation program that the government buy up available market stocks, so long as the market price was below 90 percent of the support price. A corresponding reduction of government inventories was added in periods where the price was greater than 110 percent. This is in effect for the results reported in this paper.Recall that acreages, yields. and thus production of both wheat and feed grains were estimated to be functions of expected real profits from participation and non-participation in government programs. Acreages and yields are not particularly responsive to conditions in the marketplace, mainly because of favorable settings on target prices. Both appear to be dominated by the favorability of agricultural policy, with actual market prices having less of an effect. Table 4 reports production figures from our simulations. Actual figures from 1983 are included for comparison. Table 5 gives actual market prices for 1983 and those which resulted from each simulation for the 1984-1986 period. Real prices are higher in the subsidy simulation for the first half of the period for feed grains and for the second half for wheat. When real prices are higher during the tax period, it is due to the support provided by government stock accumulation. As can be seen from the results in Table 6, exports play an important role in transmitting the effects of monetary policy to the agricultural sector.Domestic demand for wheat and feed grains is fairly inelastic, but exports are dose to twice as large by the last qu-arter of 1986. Particularly in the case of wheat, which is more sensitive to exchange rate movements, the effect of an expansionary monetary policy and a cheap dollar shows up in increased exports. Tables 7 and 8 give the total stocks of feed grains and wheat in all positions. along with the percentages in government-owned, farmer-owned reserve. and readily available stocks. Movements in inventories are a major determinant of real prices; all inventories have a depressing effect on price, but the size of these effects differs, reflecting the ease with which stocks of different types can reach the market. As one would .T expect. the total inventories of both feed grains and wheat are higher during the tax scenario. The distribution across the three inventory positions differs. as well. Market stocks are lower due to the higher real interest rate during the tax scenario. At the same time, government-owned stocks rise due to the price support operations imposed during the simulations–keeping price above 90 percent of support requires the purchase of feed grains. This adds to the interest rate effect in reducing market stocks. The farmer owned reserve is also somewhat higher during this period. The interest rate effect also causes market stocks of wheat to be lower during the tax period. In addition. price support operations again caused grain to move from market to government-owned positions. Cash price being near the support price also gave farmers incentives to participate in the farmer owned reserve. Tables 9 and 10 reveal that the livestock sector benefits from the same monetary policy that subsidizes the wheat and feed grains sectors. Table 9gives prices for beef, pork, and broilers for each scenario. and Table 10 gives breeding inventories for these sectors. With the exception of poultry for the first few quarters of the simulation, real prices are higher throughout the subsidy scenario. Because of the more favorable profitability levels in that simulahon, animals are retained for breeding purposes in all three livestock sectors, especially the hog and poultry sectors.