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Inflation and Food Prices; Who You Gonna Blame? Global Interdependence Center University of Memphis McVean Trading Memphis Economic Club

Conference on Food and Inflation Memphis Tennessee February 8, 2012

Prices change and when they change, they are often big changes. Overall, the CPI was flat between November and December. But that doesn’t mean all prices—or even most prices—were were unchanged. As I said, prices change. 30

Weight in the CPI

Non-food 25

Food 20

<-20 -20 -19 -18 -17 -16 -15 -14 -13 -12 -11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 >20

Monthly percent change (December)

The adage that prices change is pretty clear in food. This is the CPI food component. Swings of +5% or -5% are fairly common events. And remember, these are MONTHLY changes. 20.0%

Monthly percent change in retail (CPI) food at home prices

15.0%

10.0%

5.0%

0.0%

-5.0%

-10.0%

-15.0% 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 - Jan - Jan - Jan - Jan - Jan - Jan - Jan - Jan - Jan - Jan - Jan - Jan - Jan - Jan - Jan - Jan - Jan - Jan - Jan - Jan - Jan - Jan

Food actually represents a reasonably small share of food pricesâ€Ś Distribution of average retail food costs labor crop transportation energy packaging other

This bit is actual food (19%) 4

And these wide swings in prices have a tendency to cause the cost of a retail marketbasket of stuff—like what is measured by the government’s CPI statistic—to fluctuate pretty widely from month to month. 20

Percent change

Monthly CPI increase

-5

-10

-15

-20

-25 1991 - 1992 - 1993 - 1994 - 1995 - 1996 - 1997 - 1998 - 1999 - 2000 - 2001 - 2002 - 2003 - 2004 - 2005 - 2006 - 2007 - 2008 - 2009 - 2010 - 2011 Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan

Most economists simply use backward looking 12-month averages to â€œsmoothâ€? out these fluctuations. That would make discerning shifts in the inflation trend pretty slow in real time. 20

Percent change

Monthly CPI increase

-5

12-month trend growth -10

-15

-20

I prefer to just trim out the tails of the price change distributionâ€”regardless of what kind of good the outsize price change represents.

Weight in the CPI

Ignore any price change smaller than thisâ€Ś

Ignore any price change larger than thisâ€Ś

<-20 -20 -19 -18 -17 -16 -15 -14 -13 -12 -11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 >20

Monthly percent change (December)

Percent change

Monthly CPI increase

-5

16% trimmed-mean CPI

-10

-15

-20 1990 -1991 -1992 -1993 -1994 -1995 -1996 -1997 -1998 -1999 -2000 -2001 -2002 -2003 -2004 -2005 -2006 -2007 -2008 -2009 -2010 -2011 Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan

I Hear This A Lot… No Inflation? That's Not What Food Prices Are Saying Monday, 28 Feb 2011 | 1:18 PM ET

CNBC Reports

…rising grocery costs are a major threat… Of course, we live in the land of no inflation. Core cost of living is cruising along in the 1 to 2 percent range, according to government calculations, indicating that we have nothing to worry about when it comes to inflation concerns. One can only imagine that the economists who project these assertions don’t have to eat. 9

Food prices have been on a tearâ€”at least they were leading up to the crisis, and (on average) over the recovery. CRB Commodity Spot Price Indices Index: 1967=100 700

600

500

400

300

200

100 Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

through January 2012

All commodities

Foodstuffs

Livestock & Products

Fats & Oils

Source: Commodity Research Bureau

Who you gonna blame?

Here are your choices.

1.3 billion Chinese and the rest of the rapidly growing emerging economies

Here are your choices.

Dennis Lockhart

1.3 billion Chinese and the rest of the rapidly growing emerging economies

Assume you live in a world where the only thing to buy is corn and you must use dollars to buy it.

Oh, and thereâ€™s a central banker in this world too. (But he can only print money, he canâ€™t make corn.)

Private note to economists with apologies to Fed: Yes, Iâ€™m assuming no value added by central bankers.

Specifically, imagine two corn to buy and two dollars in circulation. What is the price of corn in this world?

What is the price of corn in this world?

$1 $1

And if some corn disappears? What is the new price of corn?

This is known as a change in the “cost of living”—it ain’t inflation.

Note to anyone reading these notes: You can also think of this as a decline in productivity.

Can the central banker prevent the price of corn from rising if this happens?

Note to anyone reading these notes: You can also think of this as a decline in productivity.

Yes, the central bank can reduce the money in circulation so that corn still cost $1.

But the central bank can’t change the reality that you still live in a world with only one corn. (So the cost of living will be higher—even if the price of corn doesn’t reflect it.)

Damn, if only the FOMC could make corn.

Note to wonks: This would imply a halving in wages—but this model doesn’t have production. Trust me.

Now imagine you are back in the world with two corn and two dollarsâ€Ś

$1 $1

…and that central banker puts two more dollars into circulation.

Again, the price of corn doubles. This is “inflation.”

$2 “Inflation is always and everywhere a monetary phenomenon.”

Here are the two basic scenarios in which the price of corn doubles to $2. They are very different. Cost of living increase

Central bank induced inflation

Bernanke’s Take on Gas Prices and Inflation (Post-FOMC Press Conference, April 27, 2011)

Higher gas prices are absolutely creating a great deal of financial hardship for a lot of people…Our interpretation …is supply and demand. On the [demand side] we have a rapidly growing global economy…On the supply side…we have seen disruptions in the Middle East and north Africa…. There's not much that the Federal Reserve can do about gas prices per se. …After all, the fed can't create more oil.

But canâ€™t this guy be to blame?

Dennis Lockhart

But itâ€™s hard to deny that our balance sheet is looking a little pudgy these days. (So the raw material for money growth is certainly out there.)

So how can we distinguish between the two price increases? This is how economists think of the inflation process.

RETAIL PRICES

MATERIAL PRICES

PRODUCER PRICES

LABOR COSTS

MONEY AND CREDIT GROWTH

INFLATION EXPECTATIONS

Food prices could be the leading edge of a monetary inflation in an old fashioned wayâ€”the Federal Reserve could potentially be creating too much demand and this, for some reason, is centered on food purchases.

RETAIL PRICES

MATERIAL PRICES

PRODUCER PRICES

LABOR COSTS

MONEY AND CREDIT GROWTH

INFLATION EXPECTATIONS

Despite the incredible growth in the balance sheet of the Federal Reserve, the growth in bank credit over this period was exceptionally weak. Bank Credit Percentage change from a year ago, Monthly, SA 20

-5

-10 Jan-00 Nov-00 Sep-01 Jul-02 May-03 Mar-04 Jan-05 Nov-05 Sep-06 Jul-07 May-08 Mar-09 Jan-10 Nov-10 Through April

Source: Federal Reserve Board

This means the growth in money has been modest despite the expansion of reserves. Indeed, the recent trend in M2 growth, combined with the consensus GDP forecast of economists, suggests an inflation trend of between 1Â˝% to 2%.

Money Growth (M2) Percentage change from a year ago, Monthly, SA 15 13 11 9 7 5

3 1

-1 -3 -5 Jan-00 Nov-00 Sep-01 Jul-02 May-03 Mar-04 Jan-05 Nov-05 Sep-06 Jul-07 May-08 Mar-09 Jan-10 Nov-10

Note: For you econ nerds, using MV=PT, thatâ€™s 4.8% + 0% = 1.6% + 3.2%) Source: Federal Reserve Board

If monetary policy is the cause, the path from food prices to inflation works through inflation expectations.

RETAIL PRICES

MATERIAL PRICES

PRODUCER PRICES

LABOR COSTS

MONEY AND CREDIT GROWTH

INFLATION EXPECTATIONS

The survey data and information from TIPS yields did not show a significant increase in inflation expectations during the run-up in food commodity prices.

Moreover, if inflation expectations are creating an environment of food speculation, some amount of hoarding has to occur. But over the period of rapid food price hikes, food inventories were falling, not rising. 20

Billions of real dollars

Real Farm Inventory Change

-5

-10

-15

-20

-25 2000 - Q1 2001 - Q1 2002 - Q1 2003 - Q1 2004 - Q1 2005 - Q1 2006 - Q1 2007 - Q1 2008 - Q1 2009 - Q1 2010 - Q1 2011 - Q1

Maybe food prices weren’t part of an incipient monetary inflation. The evidence suggests a more old-fashioned cause…

RETAIL PRICES

MATERIAL PRICES

PRODUCER PRICES

LABOR COSTS

MONEY AND CREDIT GROWTH

INFLATION EXPECTATIONS

Indeed, there is fairly strong evidence that the recent rise in global industrial activity and an assortment of supply issues are the root cause of commodity price pressure. Global Industrial Production and Commodity Prices January 2002 = 100 275

145 140

250

135 225 130 200

125

175

120 115

150 110 125

105

100

100 2002

2003

2004

2005 CRB Index (left)

2006

2007

2008

2009

2010

Global Industrial Production (right)

Sources: Commodity Research Bureau, Netherlands Bureau for Economic Policy Analysis, and Haver Analytics

2011

Inflation and Food Prices; Who You Gonna Blame? Memphis Tennessee February 8, 2012