Understanding Food Prices

With commodity prices 35% higher than a year ago, there’s been much talk about food inflation.  Last week, the Department of Agriculture confirmed their earlier estimate that food prices would increase 3 – 4% this year.  Below, you will find what I think you should know about food prices.  At the end of the article, you’ll see my sources.  Many of the ideas in my write-up come from “Rising Prices on the Menu” by Thomas Helbling and Shaun Roache and some sentences in this summary are lifted directly from their article.  If you’re interested in this subject, I highly recommend their article (there’s a link at the end).

Why Have Food Prices Increased?

1.     Emerging market demand. Consumers in emerging markets are becoming wealthier and demanding more high-protein foods (meat, dairy products), edible oils, fruits and vegetables and seafood.  Emerging and developing economies have accounted for approximately three-quarters of the total growth in global demand for major crops since the early 2000s.

2.     Biofuel demand. High demand for biofuels has increased demand for feedstock crops.  In 2010, the production of corn-based ethanol used 15% of the global corn crop.  Biofuel demand also affects cane sugar, palm kernels and rapeseed.

3.     High oil prices. High oil prices also affect the cost of producing food because fuel is used to produce inputs (such as fertilizer).  It’s also used throughout the production process (from sowing to harvesting to distribution).

4.     Slowing agricultural productivity. Food prices have stayed low as the result of increasing productivity growth.  Unfortunately, this productivity growth has slowed.

5.     Temporary weather factors. The run-up since mid-2010 has been largely weather related.  When weather normalizes, prices should return to normal.

6.     Lower stocks. Stocks of storable food products have decreased.  This also results in more price volatility.

7.     Quantitative easing. Fed policy has pushed investors into riskier investments – including agricultural commodities.

Is It True That This is Just a Weather Related Price Spike?

Food prices have risen steadily since 2000.  This disproves the idea that high prices are simply the result of temporary factors.  With that said, these temporary factors have had an impact and may have resulted in the price spike that we’ve seen in the past year.

What is the Impact of Lower Agricultural Productivity?

1. If productivity growth slows, we need to use more land to produce more food products.  But, this results in higher prices.  In addition, the new land may not be as productive (lack of irrigation, poor infrastructure, lower soil fertility).

2. Using land for one crop often comes at the expense of another crop.

Why Are Food Prices So Volatile?

There are many volatile factors which impact prices:

1. Weather

2. International food markets are relatively shallow.  As a result, when a country changes from an exporter to an importer of a particular product, it can have a huge impact.

3. We tend to also see protectionism increase.  Countries may ban exports (in order to keep domestic prices low).  Again, this can have a tremendous impact on prices.

Who Gets Hurt By High Food Prices?

1. Higher food prices hurt emerging and developing markets more.  This is because people in these countries spend more of their budget on food.

2. The poor in the US.  Again, more of their budget goes to food.  For the median U.S. household, food and energy are approximately 17% of both expenditures and after-tax income.  For the bottom 20%, these costs rise to 20.4% of expenditures and 44.1% of income.  (This reflects the idea that some of these people are using credit and savings.  This is because in this group, you have not only the poor; you also have students, business owners with temporary losses and retirees who are spending their retirement funds.)

In General, We Don’t Fear Food Price Inflation in the US.  Why Not?

1. Food is a smaller percentage of our budget.

2. The cost of the actual food is a larger percentage of the total cost in emerging and developing markets.  In the US, a large percentage of cost comes from labor, transportation, marketing and packaging (and many of these costs are not increasing as quickly).

3. The US has done a good job of anchoring inflation expectations.  Food price inflation can translate into core inflation if citizens start to have expectations of higher inflation and then demand higher wages.  This rarely happens in advanced economies.

4. Monetary policy has much higher credibility in the US and other advanced economies.  We tend to trust the Fed to control inflation.

5. In the US, inflation is not a fear right now.  We have tremendous slack in our economy.  But, food scarcity can affect the US mostly because of the impact that they can cause in other countries.

Two Last Thoughts

1. In the event that food prices did start to cause inflation, it’s strange to think about the Fed raising rates to fight this inflation.  What would the goal be – to lessen demand for food?  Obviously, the goal would be to slow the rest of the economy and lower the core inflation rate.

2. Due to the demand for food from other parts of the world, it’s possible that raising our rates wouldn’t have any impact on food prices.  In other words, if there is food price inflation, it’s possible that there is no remedy.

Sources — here’s what I read:

1. “Rising Prices on the Menu,” by Thomas Helbling and Shaun Roache, “Finance and Development”, IMF (March 2011)

2.     Speech by Cleveland Fed President Sandra Pianalto at The University of Akron (March 22, 2011)

3.     The Cost of Food and Energy Across Consumers , by Daniel Carroll, Economic Trends, Federal Reserve Bank of Cleveland (March 14, 2011)

4. “Inflated Worries, ” by Laurence H. Meyer, New York Times (March 24, 2011)

5.     Speech by New York Fed President William C. Dudley (March 11, 2011)