Some Fresh Perspectives on Price-Support Policies

Trade protection remains a prominent feature of the current world economy and likely has significant effects on industries and macroeconomies. In this paper a particular type of policy, price supports, is analyzed in a two-country, dynamic, general equilibrium model. This model brings new perspectives to the analysis in that it is monetary and has labor mobility within countries between the traded-goods and nontraded-goods sectors. It is found that: • The introduction of price supports in an economy benefits only the agents currently working in the traded-goods sector. • Cooperation among countries in setting policies results in a higher level of price supports than does noncooperation. • Price-support policies can importantly affect the transmission of monetary policy effects, introducing permanent changes in real variables where there were none before and even reversing the signs of changes in some variables. *The author gratefully acknowledges the capable research assistance of Dan Chin and Jason Schmidt. The views expressed herein are those of the author and not necessarily those of the Federal Reserve Bank of Minneapolis, the Federal Reserve System, or the Congressional Budget Office. Even as world economies enter a new era of globalization, trade protection remains a prominent feature of the economic landscape. For instance, the cost of trade protection in the European Union is estimated to be roughly 7 percent of its GDP—about $600 billion a year. Trade-protection policies of that magnitude likely have significant sectoral impacts and also could have sizable effects on the macroeconomy. In this paper, a particular type of trade-protection policy is analyzed in a model with some features that are more or less standard, as well as some features not commonly found in models of trade protection. The latter features bring some new perspectives to the analysis. The policy analyzed is price supports for the traded good. In a sense, the government is assumed to purchase quantities of the domestically produced traded good and dump them into the ocean. The policy analyzed here is a stylized version of one of many policies actually in use. Countries use, in addition, policies such as tariffs, import quotas, export subsidies, antidumping duties, and voluntary restrictions on foreign exports. However, this paper’s analysis also has implications for those other policies. The crucial differences among the policies from this paper’s perspective are their effects on government budgets and their spillover effects on the other countries. In the concluding section, implications from the present analysis are drawn for the economic effects of those other policies. The model used for the analysis is a straightforward adaptation of the Chin-Miller (1998) model. That model has some features that most economists would agree are useful in analyzing the effects of trade-protection policies: • It is a two-country trade model with the economies of each country described explicitly from the bottom up.