Agriculture Reference
In-Depth Information
τ
( )
Y
P
* 1
+
τ
P
C
=
Av P
,
(4)
E
where the tarff rate ndcated n Equaton 4 s an average across mported
products. The fall n ths tarff rate lowers the domestc prce of mported
products and therefore shfts demand away from home-produced goods.
So there must be a real depreciation (Equation 3). But now the nominal
exchange rate can carry some of ths adjustment. The queston s how
much? If monetary policy targets the consumer price level, as expressed
above, the primary shock is to the tariff rates. The nominal depreciation
cannot be so large as to reverse the effect of ths prmary shock on
the domestc prces of mported goods. The second term n Equaton 4
should therefore fall. Thus, to maintain the consumer price target a rise
n the GDP prce ndex
P
Y
is expected, so that monetary policy must be
expansonary.
But ths s not what s observed n our mult-commodty smulaton.
In fact, there is a fall in
P
Y
(a deflation), and this counterintuitive result
arises because the two price indices,
P
Y
and
P
C
, have significantly different
sectoral weghtngs. The GDP prce ndex has a collectve weghtng of 55
per cent on 'construction and dwellings', 'light manufacturing' and 'other
manufacturng' (Table A9.1) and all three of these product groups have
declnng prces drven by the tarff reductons.
Consumption, on the other hand, is spread more evenly across
commodities, and products that are not subjected to tariff changes weigh
more heavly n the consumer prce ndex. Over half of domestc consumpton
expenditure is allocated to 'other services', 'livestock' and 'other crops'.
These three sectors experence a substantal ncrease n domestc prces
whereas both 'lght manufacturng' and 'constructon' experence a declne.
The average prce of
home goods
n consumpton rses as aggregate demand
rises and this increase is sufficient to just offset the fall in the average
prce of mports n consumpton. The result s that a monetary contracton
s requred to acheve the slght
P
Y
deflation. The consequence of exchange
rate flexibility (with
P
C
targeting) is a smaller GDP price deflation and
hence a smaller real wage increase, a smaller employment slowdown, and
therefore a larger net gan from the lberalsaton.
