Agricultural Commodity Prices and Exchange Rates under Structural Change

By Hatzenbuehler, Patrick L.; Abbott, Philip C. et al. | Journal of Agricultural and Resource Economics, May 2016 | Go to article overview

Agricultural Commodity Prices and Exchange Rates under Structural Change


Hatzenbuehler, Patrick L., Abbott, Philip C., Foster, Kenneth A., Journal of Agricultural and Resource Economics


(ProQuest: ... denotes formulae omitted.)

Introduction

During commodity booms a weak dollar typically signals price increases, not only for agricultural goods but also for other commodities (see figure 1 and Frankel, 2008). Ever since Schuh's (1974) classic article, the U.S. agricultural community has had a widely held belief that agricultural commodity prices are strongly influenced by exchange rates. Occasionally, deviations from this relationship occur, likely the result of specific supply-use or macroeconomic conditions. For example, the U.S. dollar steadily strengthened from May to December 2014, a factor often cited as contributing to observed commodity price declines. Agricultural commodity prices, like those of energy and metals, initially declined, but agricultural prices seemingly disconnected for part of that period. A similar phenomenon was observed during the 2005-2008 "commodity boom" and 2007- 2008 "food crisis." Following a progressively weaker dollar, agricultural prices eventually rose with metals and energy prices, but with a long lag (Baffes and Haniotis, 2010). The apparent tendency for these variables to generally move in line with the stylized facts but to occasionally separate suggests that this important economic relationship warrants further analysis to explain why this is so.

Economic theory suggests full pass-through (i.e., unit elastic response) of agricultural commodity prices to exchange rate changes. Empirical measurement, however, typically finds incomplete pass-through to aggregate price levels (Goldberg and Knetter, 1997). Abbott (2010) argued that the United States is a large country (i.e., not a world price taker) in many global agricultural markets, so diminished impacts on prices and less than full pass-through should be expected. But empirical observations suggest greater-than-unit elastic responses. In the short run, these are possibly due to "overshooting" (Stamoulis and Rausser, 1988; Frankel, 2008) and, in the long run, because of collinearity between exchange rates and other macroeconomic variables. Additionally, changes in underlying market fundamentals can cause the agricultural commodity price-to-exchange rate relationship to change over time. In this paper, we identify specific factors conjectured to increase price responsiveness to exchange rate changes (i.e., cause structural change in this relationship), use economic fundamentals and logic to explain why, and test whether there is empirical evidence to support these hypotheses.

Previous attempts at empirical estimation of the agricultural commodity price and exchange rate relationship have proven difficult (Shane, Roe, and Somwaru, 2008), in part due to the apparent nonstationarity of these variables (see Frank and Garcia, 2010; Enders and Holt, 2012, for agricultural prices; and Engel and Hamilton, 1990, for exchange rates). While these series may be observed as individually nonstationary, the existence of a long-run equilibrium relationship can still be examined empirically via cointegration analysis (Engle and Granger, 1991). However, structural changes in relationship parameters may be mistakenly interpreted as nonstationarity (Perron, 1989) and lead to results seemingly contradicting cointegration.

The long-run supply-use factors that plausibly influence both market behavior and this relationship are 1) low stocks-to-use conditions, which follows from the theory of competitive commodity storage, and 2) policy-based factors. The theory of competitive storage indicates that demand for agricultural commodities has different levels and responsiveness parameters (i.e., different intercepts and slopes in a piecewise linear representation, Cafiero et al., 2011) under various stocks conditions: elastic under normal stocks-to-use ratios and inelastic for low stocksto-use conditions (Wright, 2011).1 Policy can also influence market behavior, including elasticity. Abbott, Hurt, and Tyner (2011) argued that policy changes in the United States-which resulted in biofuels industry expansion-and China-which adjusted soybean imports-caused demand for U. …

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