The agonies of agflation: Fuel for the body and the car

Demand for grain is accelerating not to feed humans or livestock but to fill petrol tanks. Compared with 2000, three-times more corn is used to make ethanol in America; distilleries that produce biofuels hoover up a fifth of the country’s corn supplies. Demand for cleaner energy in turn keeps demand for corn growing. Farmers are having trouble keeping pace with the burgeoning biofuel industry. And to produce more corn farmers are switching production from wheat and soya, pushing up the prices of those crops too.

On top of these pressures, rising prosperity in poorer countries, particularly India and China, is also lifting prices. Normally the response of the world’s farmers would be to increase output by planting on marginal land. This is happening.
In the coming year the International Grains Council reckons that global grain production will hit 1,660m tonnes, some 90m tonnes more than last year. Nevertheless, demand will still outstrip supply. The wheat crop hit by Canada’s run of bad weather is likely to weigh in at 607m tonnes while demand may top 614m tonnes.

And the reverberations are felt right down the menu. As grain prices rise so do the prices of other agricultural products that rely on it as an input. As the cost of keeping poultry and livestock goes up so do the prices of eggs, chickens and other meat. Even if new land is planted this may not help to push down food prices. Because generous subsidies ensure that biofuel production is handily profitable, that industry is likely to grab new grain supplies to prime its distilling towers.

Agflation can also cause headaches for central banks. In most countries, the measures of core inflation that banks monitor most closely when making decisions about monetary policy exclude food and energy prices. Both are volatile and vulnerable to supply shocks. As central banks try to control demand they tend not to react to price fluctuations caused by see-sawing supply.

But in consumer-price indices, at least in some countries, food has a greater impact. In America food carries just 14% of the weight of the consumer-price index, but in China it accounts for 33% and in India 46%. In such countries the rising price of food obviously could push up inflation levels overall. In addition, if food prices stay high, and if consumers spend less on other goods, other parts of the economy might suffer. Good reason, therefore, for central bankers and others to hope that the pain of agflation is not shared too widely.

The Economist