The effect of monetary policy on the net revenue of Western Canadian wheat producers

• Main Author: Hamilton, Neil Allen
• Published: 2012
• Online Access: http://hdl.handle.net/1993/6886

Changes in the structure of agriculture have made producers more vulnerable to fluctuations in exchange rates, interest rates and inflation rates. The aforementioned variables are interrelated, as well as being jointly influenced by the Bank of Canada's monetary policy. The simultaneous adjustments which occur as a result of a shift in monetary policy affect each subsector of the economy in a different way. This study gives special consideration to the wheat producing sector due to its relative importance within the Canadian economy. Throughout this thesis, net revenue is used as welfare measure. From a policy standpoint, it is important to determine how a change in Canada's monetary policy will impact on the net revenue (welfare) of individual wheat producers. In pursuing this goal, four specific objectives were outlined. These include: (1) to examine the theoretical relationship between monetary variables and the Canadian wheat industry; (2) to build a model which can be used to estimate the impact of monetary shocks; (3) to use the model to simulate how net revenue is affected by changes in monetary policy; and (4) to analyze the simulated results in order to provide policy prescriptions. The estimated models are used to simulate how net revenue reacts to four different monetary policies. These include: a change in the size of the money supply; and change in the growth rate of the money supply; as well as a change in the Bank of Canada's target interest rate and target exchange rate. In each scenario, the chain of events begins with a manipulation of the money supply, which in turn affects the interest rate, the Cdn./U.S. exchange rate and the domestic inflation rate. The results of the study suggest that in the short run there is a positive relationship between the net revenue of individual wheat producers and changes in the money supply. Monetary policies which lead to an increase in the money supply exert a negative pressure on interest rates while at the same time causing the Cdn./U.S. exchange rate and the domestic inflation rate to rise. When the underlying relationships are examined, net revenue is found to be negatively related to interest rates and positively related to movements in the Cdn./U.S. exchange rate. The manner in which domestic wheat prices react to a change in the Cdn./U.S. exchange rate overshadows the impacts which interest and inflation rates exert on the cost of producing wheat. Out of the four scenarios which were tested, a 1 percent change in the Bank of Canada's target interest rate produced the greatest change in a wheat producer's net revenue. Adjusting the growth rate of the money supply by 1 percent accounts for the second largest response. The third and fourth largest reactions are produced by a 1 percent change in the target exchange rate an a 1 percent change in the level of the money supply, respectively. It is important to consider all of the implications which arise from a change in monetary policy. Examining the problem from a partial equilibrium setting may shed some light on how exchange rates affect export prices, or how interest rates impact on production costs, but tells us relatively little about how a producer's overall net revenue position is affected. This study attempts to bridge the macro-micro gap by outlining a model which is capable of assessing the microeconomic impacts which result from a particular change in monetary policy.