Neutrality of Decoupled Payments in the Presence of Credit Market Imperfections

Decoupled payments have emerged as an alternative to traditional agricultural subsidies that are coupled to production decisions, in order to minimize the distorting impacts of domestic agricultural policy. Economic theory suggests that, when farmers face imperfections in key markets such as that for financial services, even lump-sum subsidies may affect agricultural output. This paper explores these issues by developing and solving a deterministic dynamic optimization model for a credit-constrained representative corn farming household in the United States. The model is parameterized using data from the USDA's ARMS database. Simulations for different levels of DP and other parameters were conducted, and three effects on agricultural output stemming from DP were found: an expanding and temporary liquidity effect; an expanding and permanent credit supply effect; and a contracting and permanent land price effect. The magnitude and direction of the final net effect depends on several factors that require further empirical research.