Understanding the Food Component of Inflation

Summary

Focus 

Changes in food prices are often treated as separate from macroeconomic developments - a nuisance that is not worth modelling. Given that they represent an important share of CPI baskets, this paper examines the extent to which food prices respond to broader macroeconomic conditions such as output gaps and inflation expectations.

Contribution 

The paper fills a gap in the economic literature, as studies on food price inflation in middle- and high-income economies have been surprisingly scant. It quantifies the extent to which variations in the food component of CPIs are affected by the state of the economy and inflation expectations – both of which are generally affected by monetary policy. It also examines how responsive retail food prices are to local crop yields, food exports, imports and international prices.

Findings 

The paper shows that a Phillips curve relation also holds for food items, and that prices of these are clearly affected by broader inflation expectations. This suggests that food items are generally responsive to monetary policy actions. That said, there are good reasons for not targeting headline inflation, as food price inflation's volatility is typically much higher than that of core inflation. The paper also shows that the link between domestic and international food price inflation is typically weak, owing to substantial market segmentation.

Abstract

This article presents evidence based on a panel of 35 countries over the past 30 years that the Phillips curve relation holds for food inflation. That is, broader economic overheating does push up the food component of the CPI in a systematic way. Further, general inflation expectations from professional forecasters clearly impact food price inflation. The analysis also quantifies the extent to which higher food production and imports, or lower food exports, reduce food inflation. Importantly, the link between domestic and global food prices is typically weak, with pass-throughs within a year ranging from 0.07 to 0.16, after exchange rate variations are taken into account.

JEL classification: E30, E31, E32, E50, F14, Q00

Keywords: crop, expectations, energy, food export, food prices, food import, food production, forecast, inflation, output gap, Phillips curve