Identifying the effects of monetary policy shocks on the farm sector

Alaa Kamal AlShawa

ISU General Staff Papers from Iowa State University, Department of Economics

Abstract: This study concerns two potential channels for the transmission of monetary policy to the farm sector in the United States. The first one is the money channel where I use a relative-price model to explain the effect of monetary policy shocks on relative farm prices. The second one is the credit channel where I use the Flow of Funds Accounts (FOFA) data to assess the effect of monetary policy shocks on net funds raised in the farm sector;The equilibrium relative-price model provides a linkage between monetary policy shocks and relative farm prices. The model shows that monetary policy can affect relative farm prices if aggregate price information is imperfect and if supply and demand elasticities in the farm and nonfarm sectors are different. The short-run elasticity of supply of farm products is argued to be less than that of nonfarm products because of differences in the production processes. This characteristic of farm production causes relative farm prices to fall initially in response to a contractionary monetary policy shock;The credit channel for the transmission of monetary policy is another way monetary policy can affect the farm sector. The credit view holds that monetary policy affects the borrowing and lending activities of the farm sector primarily because it affects the extent of financial intermediation. It suggests that the amount of bank loans might also be an important indicator of the tightness of monetary policy;A "semi-structural" vector autoregression (VAR) model is used to develop two VAR based policy shock measures---the federal funds rate and nonborrowed reserves. The effects of monetary policy shocks on the farm sector are then assessed using dynamic response functions obtained through the VAR model;Relative farm prices show a steady and persistent decline after a contractionary monetary policy shock, while net funds raised in the farm sector increase for roughly a year then decline. The initial rise in the net funds raised reflects the difficulty for farmers to quickly alter their nominal expenditures. Eventually, they reduce their nominal expenditures and net funds raised decline as predicted by the credit view.

Date: 1999-01-01
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