The Transmission of Exchange Rate Changes to Agricultural Prices
by William Liefert
and Suresh Persaud
Economic Research Report No. (ERR-76) 33 pp, July 2009
Exchange rate movements can change countries' domestic prices,
thereby affecting incentives to produce, consume, and trade goods.
For example, consider an exporting country that has a depreciating
currency. The price domestic producers receive for exporting a good
should rise because the trade price converted into domestic
currency is now higher. This benefits domestic producers and
motivates them to produce and export more of the good.
However, many countries have trade policies or market conditions
that prevent or reduce the transmission (or pass through) of
changes in exchange rates to domestic prices. This blunts the
domestic price and market response to exchange rate changes. In the
example above, incomplete transmission could keep the domestic
price, production, and export of the good from rising as much as
possible. Incomplete transmission thereby can prevent countries
from attaining the levels of production, consumption, and trade of
goods that would bring them, and their trading partners, the most
What Is the Issue?
The main reason exchange rate transmission is important for U.S.
agriculture is because a large share of U.S. agricultural
production is exported. Over the last 15 years, about a quarter of
U.S. agricultural output has been sold abroad. Incomplete
transmission of agricultural prices and exchange rates to domestic
prices within countries means, however, that these countries are
not fully integrated into world agricultural markets. They are not
trading as much as they profitably could. More specifically, as a
group they are not importing as many agricultural goods from
United States as is in their, and the United States, economic
What Did the Study Find?
The two main causes of incomplete exchange rate transmission for
agricultural products are trade policies and poor market
conditions. Trade policies that impede transmission include import
quotas and systems of managed (or fixed) agricultural prices. Poor
market conditions can involve deficient market infrastructure and
the use of market power by large buyers and sellers to set prices.
The deficiencies can be in physical infrastructure, such as roads,
transport, and storage, or in commercial and institutional
infrastructure, such as systems of market information, finance, and
law. Poor infrastructure isolates regional markets within countries
from each other, as well as cuts them off from the world market,
thus weakening transmission.
The United States has been moving away from
transmission-impeding agricultural trade and support policies, it
has fairly good infrastructure supporting the agro-food economy,
and its agricultural markets are reasonably competitive. Thus,
price and exchange rate transmission is not a serious problem for
the workings of U.S. agriculture. Empirical research shows,
however, that price and exchange rate transmission for agricultural
products is lower in developing economies than in the United States
and other developed countries. Analysis of 56 developing countries
over a 30-year period found that about a third of the countries had
almost no transmission of border price changes to domestic prices,
even after allowing for an adjustment period of 5-7 years. In 23
other countries, after 5 years, no more than half of the change in
border prices was transmitted to domestic prices.
Policies within developing economies certainly account for some
of the weak transmission. Yet, during the last 20 years, many
developing countries have liberalized their agricultural policies,
a process promoted by the 1994 Uruguay Round Agreement on
Agriculture, such that price and exchange rate transmission should
improve. However, poor market conditions, such as weak
infrastructure, continue as a serious impediment to price and
exchange rate transmission in many developing economies.
Incomplete transmission has implications for the interpretation
and use of standard measures of agricultural protection and
support. These measures all involve some sort of gap between the
domestic price for a commodity and its border price. This price
wedge is typically interpreted as a measure of the degree to which
government policies distort domestic prices, and thereby distort
market incentives to produce, consume, and trade goods. However,
measures of protection and support could be used to misidentify the
cause of price gaps. This could happen if a large part of the price
wedges were caused not by policies but by incomplete price and
exchange rate transmission resulting from market imperfections,
such as deficient infrastructure. By misidentifying the cause of
price gaps, governments might adopt inappropriate policies intended
to eliminate the gaps.
How Was the Study Conducted?
The study uses market and trade analysis to examine how changes
in exchange rates affect a country's domestic markets for
agricultural commodities. The same conceptual framework is then
used to analyze the causes and market effects of incomplete price
and exchange rate transmission for agricultural commodities. The
study also examines the empirical evidence concerning exchange rate
transmission for the United States, other developed countries, and,
particularly, developing countries, as well as evidence that market
conditions alone can cause incomplete transmission.