EDITOR'S NOTE: We’re all aware of the investing mantra “Don’t fight the Fed.” Sure, it’s important to follow the Fed as every American has something at stake with every major Fed decision. But the Fed can only affect those things within its realm of influence. However expansive it may seem, the Fed’s capacity to effect change doesn’t extend to every segment of the global economy. Do you really think that all it takes for the Fed to rein in inflation is a Volker-style series of rate hikes? And do you think that the central bank can pull off a “soft landing” while at it? If you answered “yes” to both, then you must assume that the rising cost of goods is ALL within the Fed’s sphere of monetary control. Like food, which is critical in that it has “inelastic” demand. As a Credit Suisse economist, cited below, says, the Fed can’t print “oil to heat or wheat to eat.” Some of these problems do not originate from within America’s domestic production. Runaway food prices are among them. To tackle food inflation, the Fed must have the capacity to blunt factors originating from external sources (the Russia-Ukraine war, for instance, and other related sources). And that’s one critical hurdle that Volker did not have to face when he implemented the rate hikes that finally killed inflation that plagued the 1970s; of course, Volker also dragged the US economy down into recession. So, does today’s Fed really have the tools to tackle inflation?
Federal Reserve Board Chairman Jerome Powell hopes to tame the inflation monster in the style of former Chairman Paul Volcker in the early 1980s, by raising interest rates aggressively in the coming months. But he may face an obstacle that Volcker did not: rising food prices that are beyond the Fed’s control.
As Powell and other top Fed officials have clearly telegraphed, the Fed will raise interest rates by a half-point at its May meeting. The rate increase will mark the first time since 2006 that the central bank has raised the rate at back-to-back meetings, and a half-point increase would mark the first such move in 22 years.
In recent remarks, Powell invoked Volcker’s battle to control inflation by aggressively raising interest rates. The Volcker-led Fed raised the federal funds rate, which had averaged 11.2 percent in 1979, to a peak of 20 percent in June 1981. The prime rate rose to 21.5 percent in 1981.
For those of us over age 50, the soaring inflation of the late ‘70s and early ‘80s remains an indelible memory — and not a pleasant one. Inflation topped 11 percent in 1979 and 13 percent in 1980, draining the value of family savings, hurting people living on fixed incomes and prompting angry workers to demand pay increases to keep pace. It was not until 1983, after the deep 1980-82 recession (technically, two downturns over that period), that inflation dropped to near 3 percent, and it has averaged less than 2.5 percent a year ever since — meaning that more than half the population has never experienced such levels of inflation.
Can Powell’s Fed tame inflation without triggering a deep, Volcker-style recession? Here’s where food comes in.
Economists measure whether a product is “elastic” or “inelastic.” If elastic, demand falls as the price rises. Staple food products are inelastic; as prices rise, the demand does not decline proportionately.
That’s because we all need to eat. We can replace expensive food items with cheaper ones, and we can eat less but, overall, the demand for food is largely unaffected by prices. We can complain about prices at the grocery store, but we still buy milk, bread, butter and vegetables to feed our family.
So, by raising interest rates, will the Fed reduce food inflation? The experience of 40 years ago might suggest so. After food inflation peaked at 11 percent in 1979, it fell to 8.6 percent in 1980. After the 1980-82 recession and over the next four decades, food prices rose at an annual rate of 2.6 percent.
Food inflation, however, has now soared to 8.8 percent — and the problem is that it’s driven in large part by factors beyond the Fed’s control.
One factor is the pandemic-induced food supply chain disruptions of the last two years. Another is changing U.S. and South American weather patterns during the growing seasons beginning in 2020 that limit critical grain production. Still, another is Russia’s war with Ukraine — the world’s third-largest wheat grower, fourth largest corn producer, and largest sunflower grower.
As Credit Suisse’s economist Zoltan Pozsar aptly observed recently: The Fed can “print money, but not oil to heat or wheat to eat.”
Even with a perfect growing season, most major grains require seven to eight months from planting to harvest — and no one, including the Fed, can change that timeline. Nor can the Fed speed up the 118 gestation days to produce a piglet, or the six additional months it takes to get to your grocery store. The Fed also cannot cure this spring’s Midwest bird flu that has forced the culling of 24 million poultry chicken and turkeys.
By March, the Producer Price Index had risen 11.2 percent over the previous 12 months, marking the largest increase since November 2010, when the government began compiling the data as it now does, and reflecting all of the aforementioned factors that are beyond the Fed’s control. For wholesalers, all food rose 16 percent over a year ago, fruits and vegetables over 18 percent, fresh and dry vegetables an astonishing 82 percent, grains 40 percent, processed chickens 29 percent, cooking oils 46 percent and dairy products 19 percent.
These wholesale price increases are now in the agricultural pipeline and will begin to show up for consumers at the grocery store over the next many months. Powell’s Fed may be able to reduce overall inflation by raising interest rates, but its efforts may not have the desired effect at the kitchen table.
G. William Hoagland is senior vice president at the Bipartisan Policy Center, a “Hoosier Homestead” soybean and corn farmer, and former administrator of the Agriculture Department’s Food and Nutrition Service.
Originally published on The Hill.