How Did We Get Here?

C. Peter Timmer

Prices of basic foods have increased sharply since mid-2007. The causes and impact of higher prices are the subject of much analytical and policy debate, with little agreement except on the tragic consequences for the nutritional and health status of poor consumers. Fortunately, the price panics seen early in 2008 have reversed. But price levels remain well above long-run trends and significant micro and macro adjustments are in the works. How did we get here?

What Happened?

Two separate dynamics, with separate causes, are involved: a gradual increase in basic food prices since mid-decade, and then a rapid acceleration in price increases after mid-2007. The gradual run-up in prices was caused by three fundamental and interrelated factors:

  1. Rapid economic growth and structural transformation, especially in China and India, put pressure on a variety of natural resources such as oil, metals, timber and fertilizers. Demand simply increased faster than supply for these commodities, and prices for non-food commodities climbed steadily after 2004.
  2. A sustained decline in the US dollar since mid-decade added to the upward price pressure on dollar-denominated commodity prices directly, and indirectly drove a search for speculative hedges against the declining dollar—often in commodity futures.
  3. A combination of high fuel prices and legislative mandates to increase production of bio-fuels established a price link between fuel prices and ethanol/bio-diesel feed stocks—corn in the U.S. and vegetable oils in Europe. The legislative mandates in both the U.S. and Europe stem from longstanding efforts to increase agricultural prices in these rich societies to ease the pressure of rapid structural transformation on their rural economies.