Nonneutral Effects of Money Supply on Farm and Industrial Product Prices

S. Devadoss, William H. Meyers
November 1986  [86-WP 16]

Changes in relative prices or terms of trade, i.e., the ratio of farm output to farm input or nonfarm output prices, have significant implications for the farm economy. If the prices farmers receive for their outputs increase (decrease) relative to the prices they pay for their inputs, the economic well being of farmers is enhanced (diminished). The terms of trade are likely to change if general price inflation changes. Thus, movements in general price inflation can affect farm income significantly.

Recent macroeconomics literature postulates that to the extent that general inflation can in and of itself generate relative price changes, it is only the unanticipated inflation can do so. And, fully anticipated inflation has no effect on relative prices. This study examines the effect of unanticipated inflation generated by unanticipated changes in the money supply's growth rate on relative prices, and derives the implications for farm income.

Section II presents a brief survey of past studies on this issue. Section III explains the Vector Autoregression (VAR) technique, developed and popularized by Sims, which is used for the analysis. Section IF discusses empirical results obtained from the VAR methods. Finally, Section V sets forth the conclusions.

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