With a dramatic rise in the prices of foodstuffs, riots have flared up in dozens of hotspots around the world. Panicky politicians are responding with precisely the wrong policies, including production subsidies and trade controls.
The problem is clear enough: According to the International Monetary Fund, food and beverage prices have risen 60 percent in the past three years, and more than doubled since 2001.
What is going on? We can discern four forces at work today pushing up food prices—forces that were also at work in the 1970s, the last time food prices increased so rapidly on a sustained basis:
Monetary policy in overdrive. Consider the real federal funds rate—that is, the nominal funds rate less inflation. A low real fed funds rate both encourages interest-rate sensitive spending, such as business investment, and discourages global investors from supporting the dollar on foreign exchange markets. At 2.25 percent, the nominal fed funds rate is now below the prevailing rate of consumer price inflation.
Exchange-rate arrangements in disarray. The 1970s were also noted for turmoil in exchange markets, following the breakdown of the Bretton Woods system. The schism today is that some exchange rates move too little and others too much.
Unsound market interventions. Policy makers flailed about in the 1970s, enacting environmental legislation without due deference to the costs imposed on industry. They also tried to impede market forces with gasoline rationing and a brief flirtation with outright price controls.
Oil prices on the rise. The lines stretching around filling stations in the 1970s should remind us that large energy-price increases are disruptive. And we have had a large one: Crude prices have more than quadrupled since 2001. Any industry dependent on energy will feel those cost pressures, and modern agriculture, with its oil-based fertilizers and large machinery, is no exception.
The good news is that producers respond to relative prices, although it can take some time. Already, the acreage in which corn is planted in the United States is back to levels of the 1940s. More of a production response should follow in other areas as well.
Challenges abound as supply catches up with higher global demand.
The Federal Reserve has to be sensitive not to stoke inflation pressures, and to monitor inflation expectations closely. The subsidies proffered to corn producers have to be trimmed, in part to set a new standard for emerging market economies to emulate. And the gains from an open trading system have to be protected to keep our economy efficient.