What’s driving food prices?

Jul 2008

Written by Purdue University economists Wallace Tyner, Christopher Hurt and Philip Abbott, the study, What’s Driving Food Prices?, identifies three broad sets of forces driving food price increases.
The first major section is an analysis of what has been happening in the supply and utilization accounts for each major food commodity. One of the themes developed in this section is that the 2007-08 food price increase is not an instantaneous development. It has been building for many of the commodities for years. The move from a surplus era (and mentality) to a shortage situation happened in a relatively short time. The same applies to biofuels in that the biofuels induced corn price increases did not occur until stocks had fallen significantly. Another theme developed is that stocks-to-use ratios play a crucial role in determining commodity prices. When stocks are relatively high, shocks can be easily absorbed with little price change, but when stocks are low, even modest supply or demand shocks can have major impacts on price. In other words, the price response is non-linear with respect to changes in stocks-to-use ratios. We provide a commodity-by-commodity assessment of the supply and demand factors influencing price.
The second section is on exchange rates and international trade. Exchange rates, particularly the US$ depreciation, have been mentioned as a factor that might be important in several studies, but none of the food price studies has reported a data-based analysis. Several measures based on exchange rate data are used to show similarities and differences between the current and past commodity price cycles. A background on the economic forces that determine exchange rates is provided, broadening the base beyond food prices to show the extent to which commodity prices in general have moved together historically and in the recent period. The relationships between exchange rates, commodity prices, inflation and recession in the economy are assessed.
The third major section focuses on the linkage between biofuels and commodity prices. It describes the new relationship between prices of energy and agricultural commodities. In the past, energy and agricultural commodity markets have been largely distinct and have marched to different drummers. Today, because of biofuels, the price of crude oil and the price of corn are much more closely linked. Crude oil determines the gasoline price, which is linked to the ethanol price, which in turn determines the incentive to add ethanol capacity, and ethanol capacity drives corn demand for ethanol. With ethanol use approaching one-third of the U.S. corn crop, this link is becoming quite strong and this section examines the relative importance of oil price, subsidies, mandates, and import tariffs in determining the corn price.
The final section summarizes conclusions for this analysis.

By: Farm Foundation

 
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