Tuesday, June 28, 2011

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.  

7 comments:

  1. Sounds like Ireland.

    I remember Nixon's wage freeze...I was just a new employee who did not get raises for performance. The results that followed were rampant inflation during the Jimmy Carter era.

    Oil and Food inflation are being caused by many reasons. This will be with us for quite a while unless we find another planet or have a massive disaster. The emerging industrial and service countries like China will have to fulfill their demand as their society becomes more like the US. Other countries will follow as global trade expands. Alternatives will be developed ..especially for energy.

    Let's take the example based on Dr. Davidson's favorite beverage - JD. It takes a lot of corn mash and aging to make a barrel of JD. Lots of energy to produce and fertilize the corn plus the corn grown for JD competes with The corn grown for ethanol. Then there is the manufacture of glass which takes a lot of energy to make the bottle. Trucks to deliver it to all parts of the nation. The price of the JD will go up unless the manufacturer accepts less profit. They could do that if their employees and executives will forgo wage increases and bonuses. If they do that then they will be squeezed by higher energy and food prices plus fixed wages and higher prices for other items that directly or indirectly are made from oil and require energy to make.

    The point is that once inflation gets into the system it is hard to root out. Therefore doing anything foolish like Nixon did would be a disaster in the long term but look good politically in the short term.

    On the other hand, JD could look at alternate technologies and processes to produce and distribute their famous drink. Consumers may consume more if depressed about this whole mess... or less. If less then demand drops and JD has to lower its price or advertise more....or come up with a new gimmick like JD & Coke in a plastic bottle. As you can see there are a myriad of choices in the free market system with each one leading to a different set of consequences. All are governed by profit and cost.

    However if it works out,and too much manipulation of the system does not cause unintended consequences. So the consumer has to be more conservative and possibly enter into a new economic paradigm...which we are standing at the threshold ....looking at.

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  2. Stu, I reluctantly conclude from your writing that govomit – and particularly the OB administration – cannot reverse inflationary trends – as much as I’d luv to put culpability targets on “I don’t have to pay taxes” Geithner, Bernanke, and OB. I see that in addition to them being feckless they also are helpless in this context. Cost for food and energy are increasing and even if OB applied Nixon’s price\wage controls the overall economic situation would worsen – if you believe history repeats. I suggest they throw off the reins and let the economy free fall.

    Guess I’ll have to postpone my yacht purchase and heart transplant, switch from corned beef to Vienna sausage, wine to water, and use only one 40 watt light bulb after 7pm – and no AC.

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  3. JD and coke in a plastic bottle? Shame on you James.

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  4. Charles,

    I know where you live and giving up AC is not a good idea. But James decided (see above) that JD and Coke in a plastic bottle is coming so that might help though you might have to replace the JD with Ten High.

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  5. Corn is best served in a clear, glass Mason jar preferably without traces of rat and possum hair, but oft times it's near impossible to get the old vat clean when yer cookin' in the woods, and old car radiators are good hidin' places fer mice.

    One extremely large reason food prices are rising is that biofuels are using two of the primary resources used in just about every area of food production, corn and soy beans. If you happen to mix your JD or Bacardi with a bit of "Co-cola," as we call it in the South, that high-fructose corn syrup used to replace sugar in the cola is somewhat more expensive because corn is getting more scarce what with the guvmint doling our more subsidies for Farmer Jones and poor, old Archer-Daniels-Midland to grow more corn and soy beans for ethanol. So, JD is already taking a hit. The large cola-making entity here in Atlanta has already announced price increases, and I'm sure Poopsi and Dr. Pecker will soon follow suit. Taking these food staples out of the food chain and shifting them to production of rubbing alcohol is going to continue to escalate food prices. Of course, as Lar said, China is in the middle of it too. They're demanding more of everything, including food. Throw India in the mix, as well. India could solve many of their food shortages if they'd just eat all their relatives who've returned as cows.

    I believe that before Lar resorts to JD & Coke from a plastic bottle, he will fall back on his old college standbys, Annie Greensprings and Strawberry Hill. They're now sold in cardboard boxes lined with Glad kitchen trash bags.

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  6. Al, thanks for the food price info. My only response is I thought it was R-O-C-Co-Cola.

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  7. Don't fergit th' Moon Pies! They're still made in Chattanoogie!

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