Macro runs out of gas on food and energy inflation

I spent last week with some friends and they were kind enough to enlighten me about inflation. Since this is a mostly a macro blog and since I usually have my macro hat on, my first instinct is macro. So when discussions of inflation kick up I am ready with my tried and true macro approach:

·         Fiscal policy as measured by government deficits has no more than short-term impacts on inflation

·         Monetary Policy is the main macro tool to cause or stop future inflation

·         Inflation refers to changes in the whole body of prices and not just specific commodities like food or energy

·         Measures that best predict future inflation – like core or median inflation – usually ignore the behavior of erratic and highly fluctuating elements like food and energy prices

·         The conclusion is that macro policymakers at the Fed ought to carefully watch the whole structure of prices and not be too quick on the draw when they see food and energy prices rising.

That is where I would usually stop – time for a JD with a few cubes.

But is appears that the macro story isn’t enough right now. And I am beginning to see why. My friend first pointed out that despite relatively low inflation rates, real people are being hurt.  Lower income people are hurt more than others when food and energy prices rise because food and energy commands a larger share of their income. They don’t care if this decrease in buying power is called macro inflation or relative price change. They want someone to do something about it. This is as true in China as it is in the USA.

So if macro policy isn’t designed to effectively halt food and energy inflation, then what is? Second, if these policies take time to have their full impacts, it is first important to determine if this food and energy inflation is going to continue on. It makes no sense to put in a major new policy or set of policies if the inflation is going to vanish before the impacts of the policies hit. This is often the case – temporary supply factors often disrupt food and energy markets and the impacts are gone almost as fast as they came.  Third, if monetary and fiscal policies are not called for, then we need to decide what sort of policy should be used.

Judging from recent changes it looks like food and energy might keep up the rapid pace.  While the overall index for the price of food did not rise faster than the overall CPI in the last year, there were some key food sub components (meats, dairy, and oil) that did. Energy is another story, however, rising at more than 21% in the last year led by increases in gasoline and oil. The critical question is whether or not these increases will repeat or worsen. Here is where the sector experts – not macro experts – have to contribute to the policy discussion.  Experts can help us form opinions about the persistence and causes of these changes.

What are the key stories? China is usually in the middle. China uses more food and raw materials that it can produce. Other developing countries do the same. Thus an important part of the inflation story comes from world supply and demand. The Arab Spring is a wild card thrown into the equation. With less oil coming out of Libya, oil prices quickly rose. OPEC is in disarray and one can only wonder how Middle East oil producers will act in the future as the revolutions spread. While world oil and US gasoline prices have fallen from recent highs, it is hard to be optimistic that the next political upheaval in the Middle East won’t bring a repeat of oil prices above $100 per barrel. 

This blog is no place to start listing all the factors that impact food and energy prices. The discussion above, however, is meant to remind us that changes in these prices are often subject to very temporary factors and/or derive from sources that are beyond the control of the US government. This is not to say that there are no US policies that could help. But it does underscore the limits of policies.  President Nixon’s infamous Wage and Price Controls (1971 to 1974) are a case in point. Nixon was exasperated with what appeared to be permanent increases in the inflation rates in the early 1970s and it appeared that food and energy were catapulting increases in the prices of most goods and services. So a great believer in the free market, Nixon startled a whole nation by imposing the most un-capitalist policy he could have tried – literal government control over most wages and prices. He created a mess and later the controls ended in failure as another round of increased energy prices could not be held back. This policy example reminds us of the Dutch boy with his finger in the dike.

The policy message of this post is not very agreeable. People are hurting because of increases in food and energy prices. To the extent that these changes will continue in the future there is a case to be made for some sort of policy solution. But the causes of these increases tend to be mostly out of the reach of domestic policies and there is little history of good policy designed to quickly control the prices of food and energy.  Given the current “rock and hard place” macro situation there is a little hope that a macro anti-inflation policy will be introduced in the USA any time soon. If anything, policymakers seem more likely to create or sustain unprecedented stimulus which will only fan the flames of inflation of all goods and services.

If the government is not going to save us from inflation, then what can we do? The most obvious answer is to shop well. Some purchases can be postponed even if we don’t want to wait for them. The items that must be purchased usually offer choices. One can sometimes buy less or perhaps find substitutes.  True, the substitutes might not be as desirable as the usual goods we buy but during such a time we may not have better alternatives. Maybe some people will have to get help from friends of families. I think you get my point and you are probably not very happy about it. But sometimes life really stinks and sometimes there isn’t much we can do about it. At those times our mental well-being is often best served by turning lemons into lemonade. Sure, you can always push harder on our policymakers but be careful what you wish for.