Responding to the coffee crisis: What can we learn from price dynamics?
We develop a semi-structural price vector autoregression to capture coffee price dynamics over various time horizons. The presence of the International Coffee Agreement is permitted to alter supply responses to price signals through yield and planting effects. In the short run, the ICA caused Brazilian farm prices to become disconnected from international prices. In the long run, the ICA promoted supply response by providing a stable environment in which producers could use current price information to predict future prices. In the intermediate run, it muted supply response by necessitating an institutional price wedge between wholesale and farm level prices. In net, the ICA created a price cycle that does not exist in non-ICA periods. Oxfam's proposal to burn 300 million pounds of coffee will provide temporary relief to farmers, but cannot be used repeatedly as a long term strategy. The low coffee prices experienced since the disintegration of the ICA may be due to the interaction of supply lags, a shift in the composition of coffee demand, and low price response due to price uncertainty. No evidence of asymmetric price transmission is found.
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