World Wheat Market Instability: An Analysis of EC Price Insulation Effects

Supplyvariabd1ty (due to natural phenomena) and (to a lesser extent) demand variability are the natural causes of market price instability. Standard theory suggests that a country employing a fixed price pohcy through tanffs and subsidies rather than through buffer stocks will export its domestic pnce mstabihty to the foreign market An example is the European Community's (EC) variable levy system, which raises and stabilizes pnces m the EC. A stochastic s1mulatton with an econometnc model of world wheat markets was used to evaluate the impact of the EC policy on the world pnce level and stability. In comparison with current pohcies, the esbmated impact of border pricing by the EC was to raise the world market price by 13 percent and reduce its standard deviation by 2.3 percent. The stabdizing effect on prices is smaller than the theory suggests, because EC production var1abihty increases as a result of greater pnce uncertainty. Theoretical models usualJy assume supply price certainty with and without the price policy; but, under border pricing, production responds in an adaptive expectations framework. As a consequence, the effects of a price insulation policy on price stability are reduced.