How Will Food Prices Affect Inflation?

Summary

• An IMF working paper examines how changes in the Baltic Dry Index, a measure of the average price paid to transport dry bulk materials, affects inflation.
• The results show that when freight rates double, as they have done since early February, YoY headline inflation rises 0.7pp over 12 months.
• The analysis helps us estimate the impact of both supply chain issues and rising global food prices.
• Using the IMF’s model, we show that Q1 2022 global food prices rises could add as much as 1.5pp to headline inflation by Q3 2022.

Introduction

This week, Bank of England Governor Andrew Bailey warned of soaring food prices because of the Russia-Ukraine war. Such sentiment echoes the US Department for Agriculture, which sharply raised its 2022 forecasts for food prices last month. This inflationary pressure will add to existing housing and wage inflation that was already set to keep US headline inflation above 4% in 2022.

A new IMF working paper provides an appropriate framework for quantifying the short-term impacts of the Russia-Ukraine conflict on 2022 headline inflation. The authors use a panel of 46 countries over nearly 30 years to examine how increases in global shipping costs affect domestic inflation.

We replicate this model and run it for a change in world food prices, finding a 7% QoQ rise in global food prices increases headline inflation by roughly 0.6pp after six months.

Supply Chain Issues

The Baltic Exchange Dry Index (BDI) peaked in October 2021 at 5650. The cost of shipping containers by maritime freight had increased by over 500% since the pandemic, while the cost of shipping bulk commodities by sea had tripled. For context, the sea carries more than 80% of the world’s traded goods. And these goods imports amount to some 38% of GDP on average.

While the pass-through to inflation is less than that for fuel or food, it was inevitable that pandemic-induced supply disruptions would increase inflation in 2022. Firstly, changes in global shipping costs directly affect import prices because the local price of imported goods increases proportionately with the cost of shipping. Secondly, it affects intermediate inputs, putting additional cost pressures on producers. Lastly, as is perhaps becoming more conceivable, a wage-price spiral has second- and third-round effects on core inflation.

The IMF paper is one of the first to draw attention to the impacts of shipping costs on inflation. The systematic analysis focuses on how month-on-month changes in the BDI influence domestic inflation in both advanced and developing economies. It also examines how the inflation dynamics differ depending on a country’s structural factors and monetary policy frameworks.

The authors use the BDI index as a proxy for global shipping costs because it offers a long comparable time series at a daily frequency. And it covers 100% of the bulk dry cargo in transit on the world’s oceans. Also, dry bulk markets are decentralized spot markets, and dry bulk ship rates are likely to reflect real-time conditions in the supply of and demand for their services.

Data and Methodology

The authors’ baseline sample covers monthly data since 1992 and 46 countries, of which 30 are advanced economies. For all these countries, the authors collect headline CPI and output gap data. They also control for global food and oil prices – two major drivers of headline inflation. For subsequent analysis, they collect producer and import prices to estimate the direct and indirect price effects mentioned above.

For robustness, they control for other variables that may affect shipping costs, such as the growth rate of China’s industrial production alongside the world output gap. They also control for equity market volatility (VIX) – a driver of the global financial cycle – and the nominal effective exchange rate.

The authors’ method is called a ‘local projection’ model. It is a natural alternative to a VAR, and it simply regresses MoM changes in shipping costs on YoY inflation, controlling for differences across countries (country-fixed effects) and the other variables mentioned above. From this, you can simply calculate the impulse response functions, which give the percentage-point change in inflation from a one-standard-deviation shock to the Baltic Dry Index.

How Rising Global Shipping Costs Impact Inflation

The authors estimate the impact of a rise in global shipping costs on the average headline inflation for the 46 countries in the sample. The shock induces a steady rise in inflation over one year, peaking after 12 months (Chart 1).

Quantitatively, roughly a 20% MoM increase in the BDI increases average domestic inflation by 0.15pp at its peak, after one year. In the context of the pandemic, it means that the increase in shipping costs observed in 2021 could increase inflation by about 1.5pp in 2022. Also, the recent rise in the BDI since the start of the Russia-Ukraine war may have added a further 0.3pp to YoY inflation so far – potentially rising to 0.7pp by February 2023.

Next, the authors break this headline inflationary response down into its impact on core inflation, producer price inflation, import price inflation and inflation expectations (Chart 2). First, the impact on core inflation is only a third as large as the impact on headline inflation (Chart 2, Panel A). However, it declines less sharply than headline inflation after 12 months, implying some second-and third-round effects coming from the impact on domestic wages.

Furthermore, the authors find the impact of a rise in global shipping costs on producer price and import price inflation to be stronger than headline inflation (Chart 2, Panels B and C). That they are larger perhaps reflects the lack of pass-through from importer and producers to consumers. Furthermore, the results show that a rise in the BDI affects importer and producer costs quite quickly – within two to four months. Finally, the authors find that shipping cost rises also influence 12-month-ahead inflation expectations (Chart 2, Panel D).

The above results are shown for the average country in the sample. Breaking the results down by country groups shows that the advanced economic inflation response is roughly 30% lower. In other words, the pandemic impact would be closer to 1pp on 2022 US inflation, rather than 1.5pp average. According to the authors, this is consistent with the evidence that freights costs are decreasing in the level of GDP per capita. As such, the inflationary impact from a global increase in BDI is largest for lower-income countries.

Non-linear effects are also present in the results. That is, larger increases in shipping costs lead to faster pass-through to headline inflation. Also, in countries with an above-average import share (i.e., consumers enjoy more imported goods) or which are more integrated into global supply chains, the inflationary increase after 12 months can be nearly 60% higher. Similarly, countries that typically pay higher freight costs – landlocked countries, low-income countries, and especially island states – see more inflation when these rise.

Lastly, the authors show that a strong and credible monetary policy framework can play a role in mitigating the second-round effects from import prices and inflation. The analysis shows that keeping inflation expectations well-anchored is key to containing the effect of soaring shipping costs on consumer prices, particularly core measures that exclude fuel and food.

How Rising Global Food Prices Impact Inflation

The results so far focus on the inflationary impact of a rise in global shipping costs. For a given level of volatility, this pass-through from shipping costs to domestic inflation tends to be smaller than the pass-through from changes in oil and food prices. To quantify the impact of a rise in global food prices on headline inflation, we replicate the IMF’s model for their baseline results, i.e., Chart 1.

Like the IMF, we regress changes in global food prices on YoY headline CPI. The sample runs from 1996 to 2021 and covers 35 countries, of which 20 are advanced economies. We control for oil price and BDI changes, as well as country-level output gap differences. The impulse responses show the percentage-point changes in YoY headline inflation from a one-standard-deviation change in quarterly world food prices.

Our results show that a one-standard-deviation shock, equivalent to roughly a 7% QoQ rise in the IMF’s world food price index, leads to a 0.6pp increase in YoY inflation within six months (Chart 3, orange line). For context, the end of period index rose 18% in Q1 2022, meaning global food price rises so far could add as much as 1.5pp to headline inflation by Q3 2022. These impacts remain present for up to 18 months after the initial shock (only significant for first six quarters) and are higher for EM countries.

The results align with the IMF, which finds that the impacts of food and oil price shocks are passed through to consumers faster than rises in global shipping price costs. The degree of pass-through is also similar to those found by the IMF – the authors estimate that a 3% MoM rise in global food prices increases headline inflation by 0.2pp after seven months.

Bottom Line

UK headline inflation has now reached 9% YoY. In the US, it is 8.3%. This must be a concern for policymakers. With housing and wage inflation remaining major contributors throughout 2022, the additional price pressures from shipping costs and food price rises could keep headline inflation near these ranges for some time to come. The second order impacts could be significant, especially in terms wages and consumption.