Dairy Policy and Price Volatility

The US dairy industry is shaped by a patchwork of regulations accumulated over a long history of intervention to achieve various, sometimes conflicting, policy goals. Price supports have long been a central feature of dairy markets, but were largely withdrawn beginning in 1988. Since that time, there has been a dramatic increase in the variability of farm milk and milk product prices. The origins and desirability of volatility has been the subject of much debate; unfortunately models in existence to date have shed little light on the question due to their adoption of essentially non-dynamic methods. This article introduces a dynamic, behavioral dairy model to investigate variability and possible countermeasures. The model suggests a number of factors that may contribute to price volatility, in addition to the usual explanation of supply-chain amplification of random supply and demand shocks. The behavioral response of industry participants to price and inventory signals, the use of long-term contracting, speculative hoarding, coupled long-term cycles of processing capacity and herd size each contribute their own component of volatility. Some well-intentioned regulatory and industry policies attenuate the price signals directing milk supply to demand, exacerbating volatility, whereas price supports and the availability of trade provide some damping.