The IMF is set to advise developing economies to tighten monetary policy, to deal with rising food prices feeding through into core inflation, economists at the Fund have warned.
They say increases in food prices are likely to stabilise, producing not only the direct “first-round” effects seen in 2007-08 and again this year, but also longer-term “second-round” effects, i.e. they feed through into core inflation.
The risk of food prices passing through to core inflation is “significant for emerging and developing economies”, Thomas Helbling, advisor, and Shaun Roache, economist, in the IMF research department, said in an article published this month.
“If people expect food to continue to go up in price, they begin to demand higher wages, leading to increased core inflation”, Helbling and Roache pointed out.
“The IMF has traditionally advised countries to accommodate the first-round, direct effects of rising commodity prices on inflation, but to be prepared to tighten monetary policy to avoid second-round effects.”
The pass-through problem “has not become acute yet, but core inflation has been increasing systematically in many emerging economies”, Thomas Helbling told Emerging Markets.
Emerging economies would be impacted more significantly, because of food’s greater share of household budgets – and also because “despite progress in many countries, the credibility of monetary policy generally is not as well established as in advanced economies”.
He added that macro-economic policies could not be shaped in isolation from measures to ensure that social safety nets are in place and that the poorest people are protected.
Helbling and Roache believe that a large part of the recent surge in food prices is due to temporary factors such as the weather, but that “the main reasons for rising demand for food reflect structural changes in the global economy that will not be reversed.”
The first of these is rising living standards in middle-income countries, where large numbers of people are eating more meat, dairy products and edible oils, increasing the demand for scarce agricultural resources.
Secondly, fuel prices that impact all stages of the agricultural production cycle are rising. The boom in biofuels increases the level of correlation.
Thirdly, the slowdown in agricultural productivity growth over the last decade has resulted in the increase of land use, which also feeds through to higher agricultural commodity prices.
Maximo Torero, director of markets, trade and institutions at the International Food Policy Research Institute in Washington said that the increase in world population, continuing urbanisation, and the constant rise in the proportion of meat and cereals in diets, would lead to long-term supply pressures – and therefore to higher prices over the long term.
The situation this week epitomised the problem, Torero told Emerging Markets. “Oil is getting close to the levels it reached in 2007-08: it is now at $115/barrel due to the situation in the Middle East. And rice could be affected by the situation in Japan, which is one of the largest exporters.” But these temporary problems occur in the context of structurally higher prices, he said.