The 1996 grain price shock: how did it affect food inflation? - Cover Story

Monthly Labor Review, August, 1998 by Jerry Light, Thomas Shevlin

The dynamics of food inflation appear to have changed; the 1996 grain price shocks had a smaller impact than shocks in the past

The Midwestern drought of 1995-96, rising foreign demand for U.S. feed grains,(1) and substantial commodity market speculation combined to markedly drive up feed grain prices in 1995 and 1996. This sharp increase initiated a classic pattern for food inflation. The price increases, especially those for corn, soybeans, and wheat, ignited the inflationary spiral at the most basic or crude stage of processing. As time passed, this inflationary swell spilled over into intermediate and finished goods, culminating in an overall increase in food prices.

This article tracks an inflationary spiral in food prices from the grain fields of the Farm Belt to kitchen tables across America during the drought and in subsequent months.

Mechanics of food inflation

Prices for agricultural commodities such as feed grains are inherently volatile, because they are susceptible to both supply and demand shocks. Examples of supply shocks are weather- or disease-related shortcomings, or conversely, the production of bumper crops in good years. Demand shocks usually come in the form of unexpected purchases by foreign buyers, for example, the unexpected purchase of large amounts of American wheat in the 1970s by the Soviet Union.

Any large change in agricultural prices can have a significant impact on the Producer Price Index (PPI) for crude foodstuffs and feedstuffs, the first of the PPI's three stage-of-processing indexes for foods. The impact of the price shock can then pass from crude foodstuffs and feedstuffs on to intermediate foods and feeds, and then to finished consumer foods, along the PPI's stage-of-processing model.

As price shocks pass from one stage of processing to the next, the amplitude of the shocks tends to diminish somewhat at each stage of processing. Chart 1 illustrates the effect of the 1995 grain price shock as it passes through the food industry. The graph spans January of 1995 through December of 1997, and shows the percent change for the three PPI's based on their January 1995 levels.

[Chart 1 ILLUSTRATION OMITTED]

Because feed grains are inputs to so many food products, higher feed grain prices can cause inflation to spread throughout almost the entire food industry. Higher wheat costs can cause higher flour prices, which in turn can cause higher bread, pasta, and cereal prices. Higher corn and soybean costs can cause higher prices for animal feeds, cooking oil, and margarine. By affecting animal feed prices, higher soybean and corn prices can also have very important consequences for the meat, poultry, egg, and dairy markets.

Late in the fall of 1995 and early in 1996, articles in major newspapers, magazines, and trade publications began to warn about the consequences of the skyrocketing feed grain prices on "downstream products" (intermediate goods and finished goods; for example, flour and bread are downstream products of wheat). Some industry economists and media reporters projected food inflation to be as high as 3 percent to 4 percent (at the retail level) in 1996, and that it might surpass that of general inflation for the first time since 1990.(2) These forecasts did in fact come true, as the Consumer Price Index for All Urban Consumers (CPI-U) for food and beverages rose 3.2 percent for 1996, whereas the CPI-U for all items rose 3.0 percent and the CPI-U for all items less food and energy rose only 2.7 percent. This was an unusual event, as food inflation has tended to be lower than general inflation for the past two decades. Chart 2 depicts the percent change in the annual averages of the Producer Price Indexes for wheat, corn, and soybeans from 1972 through 1996. If we define a feed grain price shock as a 20-percent or greater increase in annual average PPI'S of at least 2 of the 3 commodities, then the data indicate that feed grain price shocks occurred in 1973, 1974, 1988, and 1996.

[Chart 2 ILLUSTRATION OMITTED]

These sharp increases in feed grain prices each resulted in a surge in food inflation above the core rate (3)of inflation, as measured by both the PPI and the CPI-U. Table 1 compares the aggregate PPI for food--finished consumer food--to the `core'--finished goods less food and energy. It also compares the aggregate CPI-U for food--food and beverages--with the CPI `core'--all items less food and energy.

Table 1. Comparisons of food inflation in the Producer Price Indexes (PPI) and Consumer Price Indexes for all Urban Consumers (CPI-U), 1973-97

[In percent]

                         PPI

Year      Finished consumer   Finished good less
                foods          food and energy
                              (`core' inflation)

1973(1)         20.50               24.6
1974            14.00               11.40
1975             8.40               11.40
1976             -.30                5.70
1977             5.30                6.00
1978             9.00                7.50
1979             9.30                8.90

1980             5.80               11.20
1981             5.80                8.60
1982             2.20                5.70
1983             1.00                3.00
1984            14.40                2.40
1985              -80                2.50
1986             2.60                2.30
1987             2.10                2.40
1988             2.80                3.30
1989             5.40                4.40

1990             4.80                3.70
1991             -.20                3.60
1992             -.60                2.40
1993             1.90                1.20
1994              .90                1.00
1995             1.70                2.10
1996             3.50                1.40
1997              .70                 .40

                        CPI-U

Year      Food and beverages   All items less food
                                   and energy
                               (`core' inflation)

1973(1)        13.20                 3.60
1974           13.70                 8.30
1975            8.50                 9.10
1976            3.20                 6.50
1977            6.00                 6.30
1978            9.70                 7.40
1979           10.70                 9.80

1980            8.50                12.40
1981            7.80                10.40
1982            4.10                 7.40
1983            2.30                 4.00
1984            3.70                 5.00
1985            2.30                 4.30
1986            3.30                 4.00
1987            4.00                 4.10
1988            4.10                 4.40
1989            5.70                 4.50

1990            5.80                 5.00
1991            3.60                 4.90
1992            1.40                 3.70
1993            2.10                 3.30
1994            2.30                 2.80
1995            2.80                 3.00
1996            3.20                 2.70
1997            2.60                 2.40