The Dangers of Monetary Policy in Agrarian Economies: A Comment

In an interesting recent article in this Journal1 Richard C. Porter presents a model “to show that, in agrarian (or predominantly agricultural) economies it may be impossible to counteract apparently temporary shifts in the price level by means of traditional monetary policy”. In Section III, to which this comment relates, he assumes a two-sector model, with one sector (agriculture) producing the single commodity (foodstuffs) in the economy and the other sector living on lump-sum transfer payments from the agricultural sector and producing nothing. These lump-sum taxes are fixed and in money form; Porter in a footnote (p. 61) assumes (incorrectly, as is discussed below) that “none of the conclusions would be altered if the tax were fixed in real terms”. Output is independent of economic considerations (determined by the “caprice of nature”). A fixed money supply is given, as is a desire to hold a certain real wealth balance relative to real income and consumption. Speculation on the basis of expectations of price changes is assumed away. The non-agricultural sector holds its real wealth only in the form of money, while the agricultural sector holds both money and hoards of foodgrains. While Porter grants that we know almost nothing about “what causes changes (and by how much) in the relative proportions of foodgrain stocks and money in rural wealth balances”, his analysis rests entirely on presumed changes in this fraction. As he indicates, with an unchanging fiaction, monetary policy is successful in maintaining a certain price level.