An article published in the New York Times yesterday notes how commodity prices have been rising sharply in the US, and how they are expected to rise even more:
“Cotton prices are near their highest level in more than a decade, after adjusting for inflation, and leather and polyester costs are jumping as well. Copper recently hit its highest level in about 40 years, and iron ore, used for steel, is fetching extremely high prices. Prices for corn, sugar, wheat, beef, pork and coffee are soaring. Labor overseas is becoming more expensive, meanwhile, and so are the utility bills to keep a factory running.”
Of course, this means that firms have to raise the prices they charge consumers. As regards food, the article notes that
“Adding to the cost of food won’t greatly distort most household budgets. Food, gas, clothing, personal care products and cleaning and laundry supplies make up less than a quarter of household spending in the United States, according to government data.”
It is no doubt true that food is a necessity (i.e., the proportion of one’s income spent on food is decreasing as one’s income increases), and so the poor suffer disproportionately from rising food prices. The article also notes that
“The sharp rise in commodity prices since last year has not translated into all new records. Food commodity prices are about 8 percent below the high in the summer of 2008.”
Actually, the truth is that food commodity prices have not yet translated into all new records in this country, but that new record is coming. Indeed, the Food and Agriculture Organization of the United Nations’ food price index has surpassed the high levels it had attained during the food crisis of 2007-2008 to hit an all-time high in January.
As a consequence of rising food prices, food manufacturers like Kraft have already announced that they would increase their prices. Likewise, restaurants are adjusting:
“Restaurants, which resisted raising prices to keep customers coming through the doors last year, are also fretting. They may take other steps too, like lowering thermostats, shrinking packaging or reducing portion sizes to minimize the sticker shock.”
Moreover,
“Some companies don’t think they can get away with charging more. PepsiCo, which makes soft drinks and snacks, like Fritos, said it would be cautious.”
The silver lining — if there is one — is that this may push people into eating fewer processed foods and eating out less at the margin, but this ignores the general equilibrium effects, i.e., the change in relative prices that will occur between processed and unprocessed foods and between a restaurant meal and a home-cooked meal. So note my use of the conditional above: this may push people into eating fewer processed foods and eating out less at the margin.
Policy Response
The article makes a pretty good case that this may trigger an episode of high inflation. This is especially likely considering that the Federal Reserve has been keeping interest rates low so as to stimulate the economy.
In response to these rising commodity prices, the Fed can either keep doing what it has been doing, in which case it is very likely that we will see an episode of high inflation, or it can raise interest rates so as to curb inflation, which will put a damper on economic activity.
On top of all that, the federal government needs to cut its expenditures so as to alleviate or eliminate the federal deficit. At best, this will have no impact on economic activity. At worst, it will put a damper on economic activity.
Some believe that the Federal Reserve cares more about keeping inflation in check than it does about anything else. I really have no opinion on this, but if it is indeed true and the Fed raises interest rates as a result, and if the federal government significantly reduces its expenditures as it should, then there will be good reasons to fear a double-dip recession, and 2008 was just practice for worse times ahead.