Application of Vector Error Correction Model (VECM) and Impulse Response Function for Analysis Data Index of Farmers’ Terms of Trade

Objectives: To determine the relationship among Price Index Received by Farmer (PIR), Price Index Paid by the Farmers (PIP) and the Farmers’ Terms of Trade (FTT) by using the model VECM, and to attempt to know the behavior of (FTT) if there is a shock in variables PIR and PIP. Methods/Statistical Analysis: Vector Error Correction Model (VECM) is a model Vector Autoregressive (VAR) which can be used for data series which are non stationery and have cointegration relationship (long term relationship). The model VECM can also be used to see the movement in one variable to give a response regarding the shock produce by another variable through the graph of Impulse Response Function (IRF). Findings: Based on the data of Farmers’ Terms of Trade in Indonesia over the periods from January 2008 to November 2013, we have determined that the best model VECM is VECM order 2 (VECM (2)). Applications: Based on the graph of the Impulse Response Function (IRF) we have established that the response of FTT toward the shock of a price both received and paid by the farmers is fluctuative and temporary over time.