Huntley Medley | Global food prices are the biggest inflation threat

When world prices make the news, the story is almost always about oil. However, a new working paper by the Bank of Jamaica (BOJ) suggests that persons may have been watching the wrong barrel. The paper measures how differently world oil, food, and alumina prices affect inflation in Jamaica and finds that global food prices are the biggest threat to the general level of price increases in the country.

The paper, The Impact of Global Commodity Prices on Jamaica’s Macroeconomic Fundamentals, by Calvin Grant, Ashaud Shirley, and Reneisha Craig, examines 25 years of quarterly data and reaches the conclusion that a rise in world food prices does considerably more damage by pushing up price levels in Jamaica than an identical rise in oil prices. The inflationary effects from food prices also last far longer. A 1.0 percentage point increase in world food prices pushes domestic inflation up by roughly a 1.0 percentage point over two years. The same increase in oil prices moves inflation by 0.23 percentage points. Alumina moves it by 0.06. This means that food’s inflationary effect is more than four times that of oil and roughly 16 times that of alumina.

The period the study covers spans diverse economic conditions. Between 2002 and 2008, commodity prices climbed as industrialisation across Asia pulled demand upward. The global financial crisis knocked them down again in late 2008. Oil prices then fell sharply between 2014 and 2016. The pandemic led to a collapse of demand in 2020. Then in 2022, the Russia-Ukraine war disrupted the export of energy and food commodities, and prices surged.

Jamaica caused none of these events and could not have prevented any of them. The question the paper sets out to answer is which of these events matters most in terms of pushing up costs when they reach our shores. The answer is largely in the math. Food makes up 33.3 per cent of the basket of goods used to measure inflation in Jamaica, and processed food, the category most directly exposed to import prices, accounts for 27.2 per cent. Energy and transport account for 16.8 per cent.

With food accounting for about 14 per cent of the equivalent basket in the United States (US) and energy making up about 6.3 per cent, it means that the same global shocks arrive in Jamaica carrying more than twice the weight they carry in the US.

PEOPLE HAVE TO EAT

What role does the matter of choice play in all of this? When fuel becomes expensive, persons can drive less, combine errands, or take the bus. When food becomes expensive, there is far less room to adjust. The paper describes this as limited short-run substitution. Jamaicans would call it having to eat.

The real story of the effect of a price shock is not in its initial impact but rather in its long-run result. The paper suggests that on the day a shock hits, oil is actually the bigger mover, domestic inflation rises 0.05 percentage points, against 0.02 after an initial food price shock. Food starts slower because distributors and producers typically absorb some of the initial increase before passing it on to consumers. But the effect of food-price increases persists, making it harder to manage. Within four quarters, it overtakes oil in impact, rising to 0.95 percentage points against 0.21 for oil, and it may stay elevated through the eighth and 12th quarters while oil’s effect fades.

The researchers point to the fact that central banks all over the world tend to respond to food and oil price shocks differently. There is the policy tendency to wait out food price shocks, which are generally read as supply-side and temporary: the result of a drought, a war, or a disruption in shipping. As oil price shocks are visible, dramatic and widely understood to feed through the whole economy, monetary authorities generally respond to them earlier. The risk the paper identifies is that while authorities wait for confirmation, the increase can work its way into inflation expectations (what persons expect price levels to be in the future) and into price-setting behaviour and thus could become embedded.

As for the policy-rate response, interest rates are normally adjusted gradually rather than in sudden jumps. If inflation climbs faster than the policy rate follows, the real interest rate (the rate after inflation is subtracted) falls. Four quarters after a food shock, the study finds the real interest rate gap to be at around minus 0.1 percentage points. Only later does it turn positive, and by the end of the period examined, it stands higher for food shocks than for oil-related inflation.

Exchange-rate movements can compound the effect. A food price shock is associated with an immediate, slight weakening of the Jamaican dollar in real terms. In effect, the currency and the world price push in the same direction, both making imports more expensive. An oil shock, on the other hand, produces a marginal strengthening of the local currency on impact that reverses within the year.

Alumina behaves in the opposite direction entirely, and for an obvious reason: Jamaica sells it rather than buys it. Higher alumina prices raise export receipts and bring in foreign exchange, strengthening the currency. The paper notes, however, that a substantial share of those profits is subsequently repatriated abroad, which is part of why higher alumina prices translate only weakly into domestic income and demand.

The study also asks another question: of the movements in inflation that forecasters cannot anticipate, how much does each commodity account for? Two years out, world food prices explain 21.8 per cent of that unexplained variation. Oil explains 7.6 per cent. Alumina explains 2.3 per cent.

WHAT THE RESEARCHERS PURPOSE

The study sets out four practical directions. First, that commodity inflation be tracked as several distinct threats rather than one, through what the authors call a Commodity Threat Matrix, assessing likely pass-through and persistence commodity by commodity.

Second, that food price intelligence be strengthened through a joint monitoring mechanism involving the bank, the Ministry of Agriculture, Fisheries and Mining, and STATIN. This should be capable of separating genuine, imported price pressure from domestic bottlenecks in logistics, distribution, and market structure. Third, that regular Global Food Inflation Decomposition Reports be produced so that the decision to look through a shock or to act on it rests on better evidence. Fourth, that the framework guiding policy interest rate decisions be examined to see whether it should respond differently, depending on which commodity is driving prices.

Beyond that, the authors point to further work worth undertaking. This includes separating imported food from locally grown produce to establish whether the persistence comes from import dependence or from domestic frictions; examining how commodity shocks feed into inflation expectations and wage-setting; and tracing the fiscal consequences for subsidies, tax revenue, and debt.

Huntley Medley is senior media and public relations coordinator at Bank of Jamaica.