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

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<-2

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>20

Weight in the CPI

Monthly percent change (December)

Non-food

Food

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.

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-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

1990- Jan

1991- Jan

1992- Jan

1993- Jan

1994- Jan

1995- Jan

1996- Jan

1997- Jan

1998- Jan

1999- Jan

2000- Jan

2001- Jan

2002- Jan

2003- Jan

2004- Jan

2005- Jan

2006- Jan

2007- Jan

2008- Jan

2009- Jan

2010- Jan

2011- Jan

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.

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

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laborcroptransportationenergypackagingother

Food actually represents a reasonably small share of

food prices…

Distribution of average retail food costs

This bit is

actual food

(19%)

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-25

-20

-15

-10

-5

0

5

10

15

20

1991 -Jan

1992 -Jan

1993 -Jan

1994 -Jan

1995 -Jan

1996 -Jan

1997 -Jan

1998 -Jan

1999 -Jan

2000 -Jan

2001 -Jan

2002 -Jan

2003 -Jan

2004 -Jan

2005 -Jan

2006 -Jan

2007 -Jan

2008 -Jan

2009 -Jan

2010 -Jan

2011 -Jan

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.

Monthly CPI increase Percent change

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-25

-20

-15

-10

-5

0

5

10

15

20

1991 -Jan

1992 -Jan

1993 -Jan

1994 -Jan

1995 -Jan

1996 -Jan

1997 -Jan

1998 -Jan

1999 -Jan

2000 -Jan

2001 -Jan

2002 -Jan

2003 -Jan

2004 -Jan

2005 -Jan

2006 -Jan

2007 -Jan

2008 -Jan

2009 -Jan

2010 -Jan

2011 -Jan

Most economists simply use backward looking 12-month averages to “smooth” out

these fluctuations. That would make discerning shifts in the inflation trend

pretty slow in real time.

Monthly CPI increase Percent change

12-month trend growth

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0

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25

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<-2

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-10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9

10

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15

16

17

18

19

20

>20

Weight in the CPI

Monthly percent change (December)

I prefer to just trim out the tails of the price change distribution—regardless of

what kind of good the outsize price change represents.

Ignore any price

change smaller

than this…

Ignore any price

change larger

than this…

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-20

-15

-10

-5

0

5

10

15

20

1990 -Jan

1991 -Jan

1992 -Jan

1993 -Jan

1994 -Jan

1995 -Jan

1996 -Jan

1997 -Jan

1998 -Jan

1999 -Jan

2000 -Jan

2001 -Jan

2002 -Jan

2003 -Jan

2004 -Jan

2005 -Jan

2006 -Jan

2007 -Jan

2008 -Jan

2009 -Jan

2010 -Jan

2011 -Jan

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.

Monthly CPI increase Percent change

16% trimmed-mean CPI

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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.

Food prices have been on a tear—at least they were leading

up to the crisis, and (on average) over the recovery.

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100

200

300

400

500

600

700

Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

CRB Commodity Spot Price Indices Index: 1967=100

All commodities Foodstuffs Livestock & Products Fats & Oils

through January 2012

Source: Commodity Research Bureau

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Who you gonna blame?

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Here are your choices.

1.3 billion Chinese and the

rest of the rapidly growing

emerging economies

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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 there’s a central banker in this world too. (But he can only print money, he can’t make corn.)

Private note to economists with apologies to Fed: Yes, I’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?

And if some corn disappears?

What is the new price of corn?

$2

$2

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

This is known as a change in the “cost of living”—it

ain’t inflation.

$2

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?

Yes, the central bank can reduce the money in

circulation so that corn still cost $1.

$1

$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.

$1

$1

Now imagine you are back in the world

with two corn and two dollars…

…and that central banker puts two more

dollars into circulation.

$2

$2 “Inflation is always and

everywhere a monetary

phenomenon.”

Again, the price of corn doubles.

This is “inflation.”

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.

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But can’t this guy be to blame?

Dennis Lockhart

But it’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

PRODUCER PRICES LABOR COSTS INFLATION

EXPECTATIONS MATERIAL PRICES

MONEY AND CREDIT

GROWTH

Food prices could be the leading edge of a monetary inflation in an old

fashioned way—the Federal Reserve could potentially be creating too

much demand and this, for some reason, is centered on food purchases.

RETAIL PRICES

PRODUCER PRICES LABOR COSTS INFLATION

EXPECTATIONS MATERIAL PRICES

MONEY AND CREDIT

GROWTH

-10

-5

0

5

10

15

20

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

Bank Credit Percentage change from a year ago, Monthly, SA

Source: Federal Reserve Board

Through April

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Despite the incredible growth in the balance sheet of the Federal Reserve,

the growth in bank credit over this period was exceptionally weak.

-5

-3

-1

1

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15

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

Money Growth (M2) Percentage change from a year ago, Monthly, SA

Source: Federal Reserve Board

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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 1½% to 2%.

Note: For you econ nerds, using MV=PT, that’s 4.8% + 0% = 1.6% + 3.2%)

If monetary policy is the cause, the path from food

prices to inflation works through inflation expectations.

RETAIL PRICES

PRODUCER PRICES LABOR COSTS INFLATION

EXPECTATIONS MATERIAL PRICES

MONEY AND CREDIT

GROWTH

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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.

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

Billions of real dollars

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.

Real Farm Inventory Change

Maybe food prices weren’t part of an incipient monetary

inflation. The evidence suggests a more old-fashioned cause…

RETAIL PRICES

PRODUCER PRICES LABOR COSTS INFLATION

EXPECTATIONS MATERIAL PRICES

MONEY AND CREDIT

GROWTH

100

105

110

115

120

125

130

135

140

145

100

125

150

175

200

225

250

275

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Global Industrial Production and Commodity Prices January 2002 = 100

CRB Index (left) Global Industrial Production (right)

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

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.

Inflation and Food Prices;

Who You Gonna Blame?

Memphis Tennessee

February 8, 2012