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Price Volatility, Reserves and Public Policy. Brian Wright Chair, Agricultural and Resource Economics UC Berkeley ICABR Ravello Italy June 19, 2013. Post- “ Inside Job ” I perceive a need for disclosure:. Recent or current grant support: AMIS initiative of G20

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Price volatility reserves and public policy

Price Volatility, Reserves and Public Policy

Brian Wright

Chair, Agricultural and Resource Economics

UC Berkeley

ICABR

Ravello Italy June 19, 2013


Post inside job i perceive a need for disclosure
Post- “Inside Job” I perceive a need for disclosure:

Recent or current grant support:

  • AMIS initiative of G20

  • Energy Biosciences Initiative (UC Berkeley, UIUC, LBL, BP, funded by BP) – researches cellulosic biofuels

  • USDA

  • NIH

  • NSF

  • USPTO

  • Giannini Foundation


Disclosure contd
Disclosure (contd.)

  • Current consulting relationships:

    • World Bank

    • FAO

  • No recent positions in commodity markets

  • No investments in agricultural input or service providers, or significant commodity market or energy market participants.

  • In past 2 years, I was a consultant/expert witness engaged by an entity that produces and exports agricultural products. I was recently an expert witness in a case involving generic drug entry in pharmaceuticals

  • I recently made a presentation at a major agricultural bank

  • Last month I was compensated by a leading investment firm for a presentation at their head office

  • I am happy to identify any of the firms involved in the above activities, should any audience member request that I do so.


Global grain markets assumptions for a simple model
Global Grain Markets: Assumptions for a simple model

  • Production is seasonal, most often with one grain harvest ht per year.

    • positive trend due to productivity increases.

  • There is an inevitable one-year lag between the investment in planting an area At and the harvest.

    • within-year planned supply can be approximated as pre-determined.

  • Expected harvest at planting, Et-1ht, is roughly proportional to planted area.

  • The realized harvest is subject to random shocks proportional to expected harvest, due to variation in the weather, the prevalence of pests, and other shocks.

  • Grain consumption is a negative function of price.

    • Positive trend due mainly to (exogenous) population increase.

    • Other demand shifters such as income and tastes and tend to be slow-acting, not “shocks”

    • So we can write the inverse consumption demand as pt = F(ct).


Simplest s d model is consistent with long run increasing production trend
Simplest S-D model is consistent with long run increasing production trend

  • Obvious (linear?) uptrend in production

  • Obvious downtrend in price in long view


Index of world detrended price vs index of detrended production for rice 1961 2012
Index of World production trendDetrended Price vs. Index of Detrended Production for Rice (1961-2012)


After detrending simplest s d model cannot explain rice price volatility
After production trenddetrending, simplest S-D model cannot explain rice price volatility

  • No consistent relation even before 2005

  • Simplest Marshallian S-D model fails if applied to rice alone


Try adding storage to the marshallian market model
Try Adding production trendStorage to the Marshallian Market Model

Assume stylized facts of major grain markets:

  • Grains can be stored from period to period without cost, waste, or “shrinkage”

  • Grain stocks cannot be negative.

  • Consumption cannot be negative.


Available supply is used in two production trendways:

  • for consumption in year t, ct and for carryout stocks, which become carryin stocks xt for the next year.

  • for carryout stocks, which become carryin stocks xt for the next year.


Available supply at time t, production trendat, for a given year comes from the current harvest htand from stocks xt-1carried in from the previous harvest:

  • at= ht + xt-1


Available supply is used in 2 ways
Available supply is used in 2 ways: production trend

  • Consumption

  • Carryout stocks

    ct= at – xt.


Sources of available supply
Sources of available supply production trend

  • Available supply atfor a given year comes from the current harvest htand from stocks xt-1carried in from the previous harvest.

  • at= ht + xt-1


If production trendstorers are competitive and aim to maximize expected profits, and the only cost of storing is the (constant) opportunity cost of capital r, then their behavior will result in the following complementary conditions for equilibrium intertemporal arbitrage:




Rice index of detrended price versus observed stock to use ratio
Rice: Index Dynamicsof Detrended Price versus Observed Stock-to-Use Ratio

  • No consistent relation even before 2005

  • Adding storage to the rice market model does not make it fit


Try aggregation of rice maize and wheat calories price and grain prices
Try Aggregation of Rice, Maize, and Wheat DynamicsCalories price and grain prices


Index of world detrended price vs index of world detrended production for calories
Index of World DynamicsDetrended Price vs. Index of World Detrended Production for Calories

  • Simple S-D model fails even for aggregate grains


Was there a perfect supply storm
Was there a perfect Dynamicssupply storm?



Us corn harvest
US Corn Harvest Dynamics


Cost push
Cost push? Dynamics


Consumption surge in india and china consider their net exports
Consumption Surge in India and China? DynamicsConsider their net exports:



Calories of 3 major grains: DynamicsIndex of Detrended Price versus Observed Stock-to-Use Ratio - maize, wheat and rice: Now it works!



Detrended price implied stocks data vs detrended observed price index for calories
Detrended DynamicsPrice-implied Stocks Data vs. Detrended Observed Price Index for Calories


Calories actual stocks vs stocks implied by price data and commodity model
Calories: Actual DynamicsStocks vs. Stocks implied by Price Data and commodity model


Actual sur vs price estimates implied sur for calories why good fit only through 2004
Actual SUR vs. price-estimates-implied SUR for DynamicsCalories(why good fit only through 2004?)


Calories index of detrended price versus observed stock to use ratio
Calories: Index of DynamicsDetrended Price versus Observed Stock-to-Use Ratio


Transfer to farmer wealth financial crisis plus biofuels
Transfer to Farmer Wealth: DynamicsFinancial crisis plus biofuels


Permanent mandate anticipated and imposed
Permanent Mandate DynamicsAnticipated and Imposed



Implication of storage model
Implication of Storage Model Dynamics

  • Relation highly nonlinear due to influence of stocks levels

  • Cannot calculate “percentages of blame”

  • Marginal effect is the key: Relevant for policy

  • Linear SR time series irrelevant


Policy options
Policy Options Dynamics

  • Self sufficiency:

  • Strategic reserves

  • Virtual reserves (IFPRI 2008)

  • Subsidize storage

  • Ban Export Bans (if you can)

  • Limit biofuels use of grains and sugar

  • Farmer risk management

  • Acquire foreign farmland and grow the national staple

  • Biofuels diversion contracts

  • GM crops?


Policy options tools for execution
Policy Options: Tools for Execution? Dynamics

  • Strategic reserves

    • Subject to political interference - almost always against security and in favor of pressing political interests

    • Acquisition and disposal rules contentious (see e.g. commodity fund rules)


Policy options tools for execution1
Policy Options: Tools for Execution? Dynamics

  • Strategic reserves

    • US strategic petroleum reserve as example

      • But substitution reduces effectiveness inevitably

      • Speculative attacks look bad, but actually can increase efficiency

    • US silver reserve as cautionary tale (among others)



Policy options tools for execution2
Policy Options: Tools for Execution? Dynamics

  • Strategic reserves

    • US silver reserve as cautionary tale (among others)


Policy options tools for execution3
Policy Options: Tools for Execution? Dynamics

  • Virtual Reserves (IFPRI 2008)

    • Naked short positions where necessary to convince markets that their price expectations will not be fulfilled?

    • What would have happened if adopted in 2007/08?


Ban export bans
Ban Export Bans? Dynamics

  • Prisoner’s dilemma

  • Export bans can prevent hunger in weak regimes

  • Fundamental trade problem:

    Biofuels as classic (but huge) price discrimination

    Divert grain from inelastic (food) to elastic energy) demand market


Acquire foreign farmland and grow the national staple
Acquire foreign farmland and grow the national staple Dynamics

  • Acquire foreign farmland and grow the national staple

    • Good deal for all? Capital or oil for land output and supply security?

    • Sovereign risk?

    • Political commitment durability?


Policy options tools for execution4
Policy Options: Tools for Execution? Dynamics

  • Acquire foreign farmland and grow the national staple

    • Buy-in from private sector?

    • Buy-in from resident peasants?

    • “terra nullius??”


Policy options tools for execution5
Policy Options: Tools for Execution? Dynamics

  • Subsidize storage?

    • Advantage: depoliticize buy-sell decisions


Policy options tools for prevention amelioration
Policy Options: Tools for Prevention/Amelioration? Dynamics

  • Political alliances, naturally

  • Reduce incentive to use biofuels by moderating oil prices?

  • Support transparency in grain markets

    • AMIS initiative

    • Reduce ignorance that generates panic


Policy options tools for execution impact of biofuels limit biofuels use of grains and sugar
Policy Options: Tools for Execution? DynamicsImpact of Biofuels: Limit biofuels use of grains and sugar

  • Not just in EU and US

  • Huge transfer to landowners and farmers

  • Huge transfer from poor consumers


Transfer to farmer wealth financial crisis plus biofuels1
Transfer to Farmer Wealth: DynamicsFinancial crisis plus biofuels


Relevance of gm for poor
Relevance of GM for poor? Dynamics

  • Depends on biofuels policy

  • Increase RFS continually?

  • If so GM can do nothing for poor

  • Not North/South issue but Landowner/Consumer


Summary
Summary Dynamics

  • Nonlinearity of response

  • Huge distributional effect of biofuels

  • Will it continue?

  • If US RFS expansion leads, others including LDCs will follow

  • More redistribution away from poor than any development policy

  • The “GM for poor” is red herring


What are the sources of insecurity
What are the sources of insecurity? Dynamics

  • Price spikes like 2007/8?

    • Wealthy countries are minority consumers – can tolerate a doubling of farm gate food prices

    • Poor countries (and especially the poorest non-farmer citizens of such countries) are vulnerable

    • Spikes force government intervention, suppression of private sector development?


What are the sources of insecurity1
What are the sources of insecurity? Dynamics

  • Price spikes like 2007/8?

    • Expect continued grain market pressure and instability if biofuels use of grains continues to expand as US farmers expect (or hope)

    • E10 to E85!


What are the sources of insecurity2
What are the sources of insecurity? Dynamics

  • Price spikes like 2007/8?

    • Expect continued grain market pressure and instability if biofuels use of grains continues to expand as US farmers expect (or hope)

    • E10 to E85!


What are the sources of insecurity3
What are the sources of insecurity? Dynamics:

  • Export bans like 2007/08?

    • Really bans??

    • May be exacerbated by state trading, lack of decentralized private initiative

    • Let’s get real!

      -no exporter government will starve its citizenry and hope to live to enjoy the rewards of trade

    • Can be fatal: Niger drought disaster after neighbors reneged on commitment to open borders


What are the sources of insecurity4
What are the sources of insecurity? Dynamics

  • Credit market failure like 2008?

    • Problems financing stocks and trade?


What are the sources of insecurity5
What are the sources of insecurity? Dynamics

  • Interruption of physical access?

    • blockade?

    • Sea lanes interruption? (Persian Gulf?)

    • Landlocked may face closed borders


What are the sources of insecurity6
What are the sources of insecurity? Dynamics

  • Obligation to neighbors in distress?

    • Saudi Arabia and Gulf states?

    • Serious topic: Blockade of Straits of Hormuz?

    • No oil out

    • No grain in to Gulf States


Whether all or most of these factors will continue to impact markets for food and agricultural products in the years to come is difficult to say. It does, though, appear that extreme weather events have become more likely as a consequence of ongoing climate change. That factor alone may mean that markets may continue to exhibit a marked degree of volatility in the future, even larger than the 'traditional' volatility that has always plagued agricultural markets. Also



References
References: Dynamics

  • Bobenrieth, E., Wright, B. D. and Di Zeng. “Stocks-to-use Ratios and Prices as Indicators of Vulnerability to Spikes in Global Cereal Markets.” Agricultural Economics (forthcoming).

  • Cafiero, Carlo, E.S.A. Bobenrieth, J.R.A Bobenrieth, and B.D. Wright. 2011.“The empirical relevance of the competitive storage model.” Journal of Econometrics, 162: 44-54.

  • Wright, Brian D. and C. Cafiero. 2011.“Grain reserves and food security in the Middle East and North Africa.” Food Security, (Suppl 1): S61–S76

    DOI: 10.1007s12571-010-0094-z.

  • Wright, Brian D. 2011. “The Economics of Grain Price Volatility.” Applied EconomicPerspectives and Policy, Vol. 33, No. 1: 32-58. DOI:10.1093/aepp/ppq033.