The Exchange Rate and U.S./Canadian Relative Agricultural Prices

The law of one price (LOP) plays an important role as a building block in theories of international trade and exchange rate determination. It also serves as a measure of integration for international commodity markets. The LOP states that in competitive markets after adjustment for transportation costs and trade barriers, identical commodities sold in different countries should sell for the same price when their prices are defined in a common currency.

The existing economic literature provides a vast body of theoretical and empirical investigations of the validity of the LOP. In general, previous evidence is mixed and there is no unanimous LOP support or refutation. The effects of exchange rate changes on agricultural outputs have been extensively studied, but the issue of the impacts on traded non-farm produced inputs has not been explored as much.

This study investigates the impact of the exchange rate ($CN/$US) on the relative prices in U.S. and Canadian agricultural markets for five major farm outputs and four non-farm produced inputs, which are traded between these two closely integrated economies. Adherence to the LOP is evaluated by examining the pass-through effects of exchange rate changes on these prices using quarterly data. The sample covers the period of 1975 - 1999, when there were substantial exchange rate movements. Regression and cointegration techniques are utilized to estimate whether and at what rate exchange rate changes are transmitted to prices. The empirical results give rise to supportive evidence in favor of the LOP for the five farm outputs. The evidence is somewhat weaker for three of the four non-farm produced inputs, and the LOP is violated for one input.