A Project Reporton

8/8/2019 A Project Reporton

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A PROJECT REPORTON

INFLATION

BY BY

---------------- -----------------

DISHA COLLEGE

OF

HIGHER SECONDARY

STUDIES


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CERTIFICATE

THIS IS TO CERTIFY THAT CHANDAN POKAR 11th

COMMERCE AS SUSSECFULLYASCOMPLETED HIS PROJECT REPORT ON THE TOPIC INFLATION.


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DECLARATION

I, MR. CHANDAN DECLARED THAT THIS IS BY AUNTHENTIC WORK FOR THE

ACADEMIC

YEAR

2010-2011

NAME

SIGNATURE


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ACKNOWELEDGEMENT

FIRSTLY, I WOULD LIKE TO EXPRESS MY EXTREME AND HEART GRATITUDE TO MY

TEACHER, MR.ARPIT JAIN, WHO GIVES ME THIS MOST INTREASTING RESEARCH

TOPIC & SUPPORT ME TO PRODUCING THIS WORK. I WOULD LIKE TO THANK THE

DEPARTMENT OF LIBRARY OF LPU. WHO PROVIDES ME THE USEFUL BOOK ON THE

BASIS OF WHICH I TRIY TO MAKE MY TERM PARPER EFFECTIVE. I WOULD ALSO LIKE

TO THANK MY PARENTS FOR.JUST ABOUT EVERYTHING..


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History

Inflation rates around the world in 2007

The term "inflation" originally referred to increases in the amount of money in circulation. Today,the term monetary inflation is generally used to distinguish such an occurrence from a generalrise in prices, sometimes called price inflation.[11] The occurrence of an increase of the quantityof money and the overall money supply (or debasement of the means of exchange) hasoccurred in many different societies throughout history, changing with different forms of moneyused.

For instance, when gold was used as currency, the government could collect gold coins, meltthem down, mix them with other metals such as silver, copper or lead, and reissue them at thesame nominal value. By diluting the gold with other metals, the government could issue morecoins without also needing to increase the amount of gold used to make them. When the cost ofeach coin is lowered in this way, the government profits from an increase in seigniorage. [14] Thispractice would increase the money supply but at the same time the relative value of each coinwould be lowered. As the relative value of the coins becomes less, consumers would need togive more coins in exchange for the same goods and services as before. These goods andservices would experience a price increase as the value of each coin is reduced. [15]

From second half of the 15th century to the first half of the 17th, Western Europe experienced amajor inflationary cycle referred to as "price revolution",[16][17] with prices on average risingperhaps sixfold over 150 years. It was thought that this was caused by the increase in wealth ofHabsburg Spain, with a large influx of gold and silver from the New World. [18] The spent silver,suddenly spread throughout a previously cash starved Europe, caused widespreadinflation.[19][20] Demographic factors also contributed to upward pressure on prices, withEuropean population growth after depopulation caused by the Black Death pandemic.

By the nineteenth century, economists categorized three separate factors that cause a rise orfall in the price of goods: a change in the value or resource costs of the good, a change in the

price of moneywhich then was usually a fluctuation in the commodity price of the metallic

content in the currency, and currency depreciation resulting from an increased supply ofcurrency relative to the quantity of redeemable metal backing the currency. Following theproliferation of private bank note currency printed during the American Civil War, the term"inflation" started to appear as a direct reference to the currency depreciation that occurred asthe quantity of redeemable bank notes outstripped the quantity of metal available for theirredemption. The term inflation then referred to the devaluation of the currency, and not to a risein the price of goods.[21]


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This relationship betweentheover-supplyofbanknotes andaresultingdepreciation intheirvaluewas noted byearlierclassicaleconomists suchas David Humeand DavidRicardo, whowouldgoontoexamineanddebatetowhateffectacurrencydevaluation(latertermedmonetary inflation) has onthe priceofgoods (latertermedprice inflation,andeventually justinflation).

Relateddefinitions

The term "inflation" usually refers to a measured rise in a broad price index that represents theoverall level of prices in goods and services in the economy. The Consumer Price Index (CPI),the Personal Consumption Expenditures Price Index (PCEPI) and the GDP deflator are someexamples of broad price indices. The term inflation may also be used to describe the rising levelof prices in a narrow set of assets, goods or services within the economy, such as commodities(which include food, fuel, metals), financial assets (such as stocks, bonds and real estate), andservices (such as entertainment and health care). The Reuters-CRB Index (CCI), the ProducerPrice Index, and Employment Cost Index (ECI) are examples of narrow price indices used tomeasure price inflation in particular sectors of the economy. Asset price inflation is a rise in theprice of assets, as opposed to goods and services. Core inflation is a measure of price

fluctuations in a sub-set of the broad price index which excludes food and energy prices. TheFederal Reserve Board uses the core inflation rate to measure overall inflation, eliminating foodand energy prices to mitigate against short term price fluctuations that could distort estimates offuture long term inflation trends in the general economy.[23]

Otherrelatedeconomicconcepts include:deflation afall inthegeneral pricelevel;disinflation adecrease intherateofinflation;hyperinflation anout-of-controlinflationary spiral; stagflation acombinationofinflation, sloweconomicgrowthandhigh unemployment;andreflation anattempttoraisethegenerallevelofprices tocounteractdeflationary pressures.

Measures

Annual inflation rates in the United States from 1666 to 2004.

Inflation is usually estimated by calculating the inflation rate of a price index, usually theConsumer Price Index.[24] The Consumer Price Index measures prices of a selection of goodsand services purchased by a "typical consumer".[25] The inflation rate is the percentage rate ofchange of a price index over time.


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For instance, in January 2007, the U.S. Consumer Price Index was 202.416, and in January2008 it was 211.080. The formula for calculating the annual percentage rate inflation in the CPIover the course of 2007 is

The resulting inflation rate for the CPI in this one year period is 4.28%, meaning the generallevel of prices for typical U.S. consumers rose by approximately four percent in 2007.[26]

Other widely used price indices for calculating price inflation include the following:

y Producerprice indices (PPIs) which measures average changes in prices received bydomestic producers for their output. This differs from the CPI in that price subsidization,profits, and taxes may cause the amount received by the producer to differ from what theconsumer paid. There is also typically a delay between an increase in the PPI and anyeventual increase in the CPI. Producer price index measures the pressure being put on

producers by the costs of their raw materials. This could be "passed on" to consumers,or it could be absorbed by profits, or offset by increasing productivity. In India and theUnited States, an earlier version of the PPI was called the Wholesale Price Index.

y Commodity price indices, which measure the price of a selection of commodities. Inthe present commodity price indices are weighted by the relative importance of thecomponents to the "all in" cost of an employee.

y Core price indices: because food and oil prices can change quickly due to changes insupply and demand conditions in the food and oil markets, it can be difficult to detect thelong run trend in price levels when those prices are included. Therefore most statisticalagencies also report a measure of 'core inflation', which removes the most volatilecomponents (such as food and oil) from a broad price index like the CPI. Because coreinflation is less affected by short run supply and demand conditions in specific markets,

central banks rely on it to better measure the inflationary impact of current monetarypolicy.

Other common measures of inflation are:

y GDP deflatoris a measure of the price of all the goods and services included in GrossDomestic Product (GDP). The US Commerce Department publishes a deflator series forUS GDP, defined as its nominal GDP measure divided by its real GDP measure.

y Regional inflation The Bureau of Labor Statistics breaks down CPI-U calculations downto different regions of the US.

y Historical inflation Before collecting consistent econometric data became standard forgovernments, and for the purpose of comparing absolute, rather than relative standards

of living, various economists have calculated imputed inflation figures. Most inflation databefore the early 20th century is imputed based on the known costs of goods, rather thancompiled at the time. It is also used to adjust for the differences in real standard of livingfor the presence of technology.

y Asset price inflation is an undue increase in the prices of real or financial assets, suchas stock (equity) and real estate. While there is no widely accepted index of this type,some central bankers have suggested that it would be better to aim at stabilizing a widergeneral price level inflation measure that includes some asset prices, instead ofstabilizing CPI or core inflation only. The reason is that by raising interest rates when


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stock prices or real estate prices rise, and lowering them when these asset prices fall,central banks might be more successful in avoiding bubbles and crashes in assetprices.[dubious discuss]

Issues inmeasuring

Measuring inflation in an economy requires objective means of differentiating changes innominal prices on a common set of goods and services, and distinguishing them from thoseprice shifts resulting from changes in value such as volume, quality, or performance. Forexample, if the price of a 10 oz. can of corn changes from $0.90 to $1.00 over the course of ayear, with no change in quality, then this price difference represents inflation. This single pricechange would not, however, represent general inflation in an overall economy. To measureoverall inflation, the price change of a large "basket" of representative goods and services ismeasured. This is the purpose of a price index, which is the combined price of a "basket" ofmany goods and services. The combined price is the sum of the weighted average prices ofitems in the "basket". A weighted price is calculated by multiplying the unit price of an item tothe number of those items the average consumer purchases. Weighted pricing is a necessarymeans to measuring the impact of individual unit price changes on the economy's overallinflation. The Consumer Price Index, for example, uses data collected by surveying householdsto determine what proportion of the typical consumer's overall spending is spent on specificgoods and services, and weights the average prices of those items accordingly. Those weightedaverage prices are combined to calculate the overall price. To better relate price changes overtime, indexes typically choose a "base year" price and assign it a value of 100. Index prices insubsequent years are then expressed in relation to the base year price. [10]

Inflation measures are often modified over time, either for the relative weight of goods in thebasket, or in the way in which goods and services from the present are compared with goodsand services from the past. Over time adjustments are made to the type of goods and servicesselected in order to reflect changes in the sorts of goods and services purchased by 'typicalconsumers'. New products may be introduced, older products disappear, the quality of existingproducts may change, and consumer preferences can shift. Both the sorts of goods andservices which are included in the "basket" and the weighted price used in inflation measureswill be changed over time in order to keep pace with the changing marketplace.[citation needed]

Inflation numbers are often seasonally adjusted in order to differentiate expected cyclical costshifts. For example, home heating costs are expected to rise in colder months, and seasonaladjustments are often used when measuring for inflation to compensate for cyclical spikes inenergy or fuel demand. Inflation numbers may be averaged or otherwise subjected to statisticaltechniques in order to remove statistical noise and volatility of individual prices. [citation needed]

When looking at inflation economic institutions may focus only on certain kinds of prices, or

special indices, such as the core inflation index which is used by central banks to formulatemonetary policy.[citation needed]

Most inflation indices are calculated from weighted averages of selected price changes. Thisnecessarily introduces distortion, and can lead to legitimate disputes about what the trueinflation rate is. This problem can be overcome by including all available price changes in thecalculation, and then choosing the median value.[27]

Effects


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General

An increase in the general level of prices implies a decrease in the purchasing power of thecurrency. That is, when the general level of prices rises, each monetary unit buys fewer goodsand services.[28] The effect of inflation is not distributed evenly in the economy, and as aconsequence there are hidden costs to some and benefits to others from this decrease in thepurchasing power of money. For example, with inflation, lenders or depositors who are paid afixed rate of interest on loans or deposits will lose purchasing power from their interest earnings,while their borrowers benefit. Individuals or institutions with cash assets will experience adecline in the purchasing power of their holdings. Increases in payments to workers andpensioners often lag behind inflation, especially for those with fixed payments.[10]

Increases in the price level (inflation) erodes the real value of money (the functional currency)and other items with an underlying monetary nature (e.g. loans and bonds). However, inflationhas no effect on the real value of non-monetary items, (e.g. goods and commodities, gold, realestate).[29]

Negative

High or unpredictable inflation rates are regarded as harmful to an overall economy. They addinefficiencies in the market, and make it difficult for companies to budget or plan long-term.Inflation can act as a drag on productivity as companies are forced to shift resources away fromproducts and services in order to focus on profit and losses from currency inflation.[10]Uncertainty about the future purchasing power of money discourages investment and saving.[30]

And inflation can impose hidden tax increases, as inflated earnings push taxpayers into higherincome tax rates unless the tax brackets are indexed to inflation.

With high inflation, purchasing power is redistributed from those on fixed nominal incomes, suchas some pensioners whose pensions are not indexed to the price level, towards those with

variable incomes whose earnings may better keep pace with the inflation.[10]

This redistributionof purchasing power will also occur between international trading partners. Where fixedexchange rates are imposed, higher inflation in one economy than another will cause the firsteconomy's exports to become more expensive and affect the balance of trade. There can alsobe negative impacts to trade from an increased instability in currency exchange prices causedby unpredictable inflation.

Cost-push inflation

High inflation can prompt employees to demand rapid wage increases, to keep up withconsumer prices. Rising wages in turn can help fuel inflation. In the case of collectivebargaining, wage growth will be set as a function of inflationary expectations, which will

be higher when inflation is high. This can cause a wage spiral. [31] In a sense, inflationbegets further inflationary expectations, which beget further inflation.

Hoarding

People buy consumer durables as stores of wealth in the absence of viable alternativesas a means of getting rid of excess cash before it is devalued, creating shortages of thehoarded objects.


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Hyperinflation

If inflation gets totally out of control (in the upward direction), it can grossly interfere withthe normal workings of the economy, hurting its ability to supply goods. Hyperinflationcan lead to the abandonment of the use of the country's currency, leading to theinefficiencies of barter.

Allocative efficiency

A change in the supply or demand for a good will normally cause its relative price tochange, signalling to buyers and sellers that they should re-allocate resources inresponse to the new market conditions. But when prices are constantly changing due toinflation, price changes due to genuine relative price signals are difficult to distinguishfrom price changes due to general inflation, so agents are slow to respond to them. Theresult is a loss of allocative efficiency.

Shoe leather cost

High inflation increases the opportunity cost of holding cash balances and can inducepeople to hold a greater portion of their assets in interest paying accounts. However,since cash is still needed in order to carry out transactions this means that more "trips tothe bank" are necessary in order to make withdrawals, proverbially wearing out the"shoe leather" with each trip.

Menu costs

With high inflation, firms must change their prices often in order to keep up witheconomy-wide changes. But often changing prices is itself a costly activity whether

explicitly, as with the need to print new menus, or implicitly.Business cycles

According to the Austrian Business Cycle Theory, inflation sets off the business cycle.Austrian economists hold this to be the most damaging effect of inflation. According toAustrian theory, artificially low interest rates and the associated increase in the moneysupply lead to reckless, speculative borrowing, resulting in clusters of malinvestments,which eventually have to be liquidated as they become unsustainable. [32]

Positive

Labor-market adjustments

Keynesians believe that nominal wages are slow to adjust downwards. This can lead toprolonged disequilibrium and high unemployment in the labor market. Since inflationwould lower the real wage if nominal wages are kept constant, Keynesians argue thatsome inflation is good for the economy, as it would allow labor markets to reachequilibrium faster.

Debt relief


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Debtors who have debts with a fixed nominal rate of interest will see a reduction in the"real" interest rate as the inflation rate rises. The real interest on a loan is the nominalrate minus the inflation rate.[dubious discuss] (R=n-i) For example if you take a loan wherethe stated interest rate is 6% and the inflation rate is at 3%, the real interest rate that youare paying for the loan is 3%. It would also hold true that if you had a loan at a fixed

interest rate of 6% and the inflation rate jumped to 20% you would have a real interestrate of -14%. Banks and other lenders adjust for this inflation risk either by including aninflation premium in the costs of lending the money by creating a higher initial statedinterest rate or by setting the interest at a variable rate.

Room to maneuver

The primary tools for controlling the money supply are the ability to set the discount rate,the rate at which banks can borrow from the central bank, and open market operationswhich are the central bank's interventions into the bonds market with the aim of affectingthe nominal interest rate. If an economy finds itself in a recession with already low, or

even zero, nominal interest rates, then the bank cannot cut these rates further (sincenegative nominal interest rates are impossible) in order to stimulate the economy - thissituation is known as a liquidity trap. A moderate level of inflation tends to ensure thatnominal interest rates stay sufficiently above zero so that if the need arises the bank cancut the nominal interest rate.

Tobin effect

The Nobel prize winning economist James Tobin at one point argued that a moderatelevel of inflation can increase investment in an economy leading to faster growth or atleast a higher steady state level of income. This is due to the fact that inflation lowers the

real return on monetary assets relative to real assets, such as physical capital. To avoidthis effect of inflation, investors would switch from holding their assets as money (or asimilar, susceptible-to-inflation, form) to investing in real capital projects.

Causes

The Bank of England, central bank of the United Kingdom, monitors causes and attempts tocontrol inflation.


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Historically, a great deal of economic literature was concerned with the question of what causesinflation and what effect it has. There were different schools of thought as to the causes ofinflation. Most can be divided into two broad areas: quality theories of inflation and quantitytheories of inflation. The quality theory of inflation rests on the expectation of a seller acceptingcurrency to be able to exchange that currency at a later time for goods that are desirable as abuyer. The quantity theory of inflation rests on the quantity equation of money, that relates the

money supply, its velocity, and the nominal value of exchanges. Adam Smith and David Humeproposed a quantity theory of inflation for money, and a quality theory of inflation forproduction.[citation needed]

Currently, the quantity theory of money is widely accepted as an accurate model of inflation inthe long run. Consequently, there is now broad agreement among economists that in the longrun, the inflation rate is essentially dependent on the growth rate of money supply. However, inthe short and medium term inflation may be affected by supply and demand pressures in theeconomy, and influenced by the relative elasticity of wages, prices and interest rates.[34] Thequestion of whether the short-term effects last long enough to be important is the central topic ofdebate between monetarist and Keynesian economists. In monetarism prices and wages adjustquickly enough to make other factors merely marginal behavior on a general trend-line. In the

Keynesian view, prices and wages adjust at different rates, and these differences have enougheffects on real output to be "long term" in the view of people in an economy.

Keynesianview

Keynesian economic theory proposes that changes in money supply do not directly affectprices, and that visible inflation is the result of pressures in the economy expressing themselvesin prices. The supply of money is a major, but not the only, cause of inflation.

There are three major types of inflation, as part of what Robert J. Gordon calls the "trianglemodel":[35]

y Demand-pull inflation is caused by increases in aggregate demand due to increasedprivate and government spending, etc. Demand inflation is constructive to a faster rate ofeconomic growth since the excess demand and favourable market conditions willstimulate investment and expansion.

y Cost-push inflation, also called "supply shock inflation," is caused by a drop in aggregatesupply (potential output). This may be due to natural disasters, or increased prices ofinputs. For example, a sudden decrease in the supply of oil, leading to increased oilprices, can cause cost-push inflation. Producers for whom oil is a part of their costscould then pass this on to consumers in the form of increased prices.

y Built-in inflation is induced by adaptive expectations, and is often linked to the"price/wage spiral". It involves workers trying to keep their wages up with prices (above

the rate of inflation), and firms passing these higher labor costs on to their customers ashigher prices, leading to a 'vicious circle'. Built-in inflation reflects events in the past, andso might be seen as hangover inflation.

Demand-pull theory states that the rate of inflation accelerates whenever aggregate demand isincreased beyond the ability of the economy to produce (its potential output). Hence, any factorthat increases aggregate demand can cause inflation.[36] However, in the long run, aggregatedemand can be held above productive capacity only by increasing the quantity of money incirculation faster than the real growth rate of the economy. Another (although much less


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common) cause can be a rapid decline in the demandfor money, as happened in Europe duringthe Black Death, or in the Japanese occupied territories just before the defeat of Japan in 1945.

The effect of money on inflation is most obvious when governments finance spending in a crisis,such as a civil war, by printing money excessively. This sometimes leads to hyperinflation, acondition where prices can double in a month or less. Money supply is also thought to play a

major role in determining moderate levels of inflation, although there are differences of opinionon how important it is. For example, Monetarist economists believe that the link is very strong;Keynesian economists, by contrast, typically emphasize the role of aggregate demand in theeconomy rather than the money supply in determining inflation. That is, for Keynesians, themoney supply is only one determinant of aggregate demand.

Some Keynesian economists also disagree with the notion that central banks fully control themoney supply, arguing that central banks have little control, since the money supply adapts tothe demand for bank credit issued by commercial banks. This is known as the theory ofendogenous money, and has been advocated strongly by post-Keynesians as far back as the1960s. It has today become a central focus of Taylor rule advocates. This position is notuniversally accepted banks create money by making loans, but the aggregate volume of these

loans diminishes as real interest rates increase. Thus, central banks can influence the moneysupply by making money cheaper or more expensive, thus increasing or decreasing itsproduction.

A fundamental concept in inflation analysis is the relationship between inflation andunemployment, called the Phillips curve. This model suggests that there is a trade-off betweenprice stability and employment. Therefore, some level of inflation could be considered desirablein order to minimize unemployment. The Phillips curve model described the U.S. experiencewell in the 1960s but failed to describe the combination of rising inflation and economicstagnation (sometimes referred to as stagflation) experienced in the 1970s.

Thus, modern macroeconomics describes inflation using a Phillips curve that shifts (so thetrade-off between inflation and unemployment changes) because of such matters as supplyshocks and inflation becoming built into the normal workings of the economy. The former refersto such events as the oil shocks of the 1970s, while the latter refers to the price/wage spiral andinflationary expectations implying that the economy "normally" suffers from inflation. Thus, thePhillips curve represents only the demand-pull component of the triangle model.

Another concept of note is the potential output (sometimes called the "natural gross domesticproduct"), a level of GDP, where the economy is at its optimal level of production giveninstitutional and natural constraints. (This level of output corresponds to the Non-AcceleratingInflation Rate of Unemployment, NAIRU, or the "natural" rate of unemployment or the full-employment unemployment rate.) If GDP exceeds its potential (and unemployment is below theNAIRU), the theory says that inflation will accelerate as suppliers increase their prices and built-in inflation worsens. If GDP falls below its potential level (and unemployment is above theNAIRU), inflation will decelerate as suppliers attempt to fill excess capacity, cutting prices andundermining built-in inflation.[37]

However, one problem with this theory for policy-making purposes is that the exact level ofpotential output (and of the NAIRU) is generally unknown and tends to change over time.Inflation also seems to act in an asymmetric way, rising more quickly than it falls. Worse, it canchange because of policy: for example, high unemployment under British Prime Minister


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Margaret Thatcher might have led to a rise in the NAIRU (and a fall in potential) because manyof the unemployed found themselves as structurally unemployed (also see unemployment),unable to find jobs that fit their skills. A rise in structural unemployment implies that a smallerpercentage of the labor force can find jobs at the NAIRU, where the economy avoids crossingthe threshold into the realm of accelerating inflation.

MonetaristviewFor more details on this topic, see Monetarists.

Monetarists believe the most significant factor influencing inflation or deflation is how fast themoney supply grows or shrinks. They consider fiscal policy, or government spending andtaxation, as ineffective in controlling inflation.[38] According to the famous monetarist economistMilton Friedman, "Inflation is always and everywhere a monetary phenomenon."[39] Somemonetarists, however, will qualify this by making an exception for very short-termcircumstances.

Monetarists assert that the empirical study of monetary history shows that inflation has always

been a monetary phenomenon. The quantity theory of money, simply stated, says that anychange the amount of money in a system will change the price level. This theory begins with theequation of exchange:

where

Mis the nominal quantity of money.

Vis the velocity of money in final expenditures;

Pis the general price level;

Q is an index of the real value of final expenditures;

In this formula, the general price level is related to the level of real economic activity (Q), thequantity of money (M) and the velocity of money (V). The formula is an identity because the

velocity of money (V) is defined to be the ratio of final nominal expenditure ( ) to thequantity of money (M).

Monetarists assume that the velocity of money is unaffected by monetary policy (at least in thelong run), and the real value of output is determined in the long run by the productive capacity ofthe economy. Under these assumptions, the primary driver of the change in the general pricelevel is changes in the quantity of money. With exogenous velocity (that is, velocity beingdetermined externally and not being influenced by monetary policy), the money supplydetermines the value of nominal output (which equals final expenditure) in the short run. Inpractice, velocity is not exogenous in the short run, and so the formula does not necessarilyimply a stable short-run relationship between the money supply and nominal output. However,in the long run, changes in velocity are assumed to be determined by the evolution of thepayments mechanism. If velocity is relatively unaffected by monetary policy, the long-run rate ofincrease in prices (the inflation rate) is equal to the long run growth rate of the money supply


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plus the exogenous long-run rate of velocity growth minus the long run growth rate of realoutput.

Unemployment

A connection between inflation and unemployment has been drawn since the emergence oflarge scale unemployment in the 19th century, and connections continue to be drawn this today.In Marxian economics, the unemployed serve as a reserve army of labour, which restrain wageinflation. In the 20th century, similar concepts in Keynesian economics include the NAIRU (Non-

Accelerating Inflation Rate of Unemployment) and the Phillips curve.

Rational expectations theory

Rational expectations theory holds that economic actors look rationally into the future whentrying to maximize their well-being, and do not respond solely to immediate opportunity costsand pressures. In this view, while generally grounded in monetarism, future expectations andstrategies are important for inflation as well.

A core assertion of rational expectations theory is that actors will seek to "head off" central-bankdecisions by acting in ways that fulfill predictions of higher inflation. This means that centralbanks must establish their credibility in fighting inflation, or economic actors will make bets thatthe central bank will expand the money supply rapidly enough to prevent recession, even at theexpense of exacerbating inflation. Thus, if a central bank has a reputation as being "soft" oninflation, when it announces a new policy of fighting inflation with restrictive monetary growtheconomic agents will not believe that the policy will persist; their inflationary expectations willremain high, and so will inflation. On the other hand, if the central bank has a reputation of being"tough" on inflation, then such a policy announcement will be believed and inflationaryexpectations will come down rapidly, thus allowing inflation itself to come down rapidly withminimal economic disruption.

The Austrian view of inflation and monetary inflation

The Austrian School asserts that inflation is an increase in the money supply, rising prices aremerely consequences and this semantic difference is important in defining inflation. [40] Austriansstress that inflation affects prices in various degree, i.e. that prices rise more sharply in somesectors than in other sectors of the economy. The reason for the disparity is that excess moneywill be concentrated to certain sectors, such as housing, stocks or health care. Because of thisdisparity, Austrians argue that the aggregate price level can be very misleading when observingthe effects of inflation. Austrian economists measure inflation by calculating the growth of newunits of money that are available for immediate use in exchange, that have been created overtime.[41][42][43] This interpretation implies that inflation is always a distinct action taken by the

central government or its central bank, which permits or allows an increase in the moneysupply.[44] They argue the government uses inflation as one of the three means by which it canfund activities (inflation tax), the other two being taxation and borrowing.[45] In addition to state-induced monetary expansion, the Austrian School also maintains that the effects of increasingthe money supply are magnified by credit expansion, as a result of the fractional-reservebanking system employed in most economic and financial systems in the world. [46]

In other cases, Austrians argue that the government creates economic recessions anddepressions through artificial booms that distort the structure of production. The central bank


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may try to avoid or defer the widespread bankruptcies and insolvencies by encouraging moneysupply growth and further borrowing via artificially low interest rates.[47] Accordingly, many

Austrian economists support the abolition of the central banks and the fractional-reservebanking system, and advocate returning to a 100 percent gold standard, or less frequently, freebanking.[48][49] They argue this would constrain unsustainable and volatile fractional-reservebanking practices, ensuring that money supply growth (and inflation) would never spiral out of

control.

Real bills doctrine

Within the context of a fixed specie basis for money, one important controversy was betweenthe quantity theory of money and the real bills doctrine (RBD). Within this context, quantitytheory applies to the level of fractional reserve accounting allowed against specie, generallygold, held by a bank. Currency and banking schools of economics argue the RBD, that banksshould also be able to issue currency against bills of trading, which is "real bills" that they buyfrom merchants. This theory was important in the 19th century in debates between "Banking"and "Currency" schools of monetary soundness, and in the formation of the Federal Reserve. Inthe wake of the collapse of the international gold standard post 1913, and the move towards

deficit financing of government, RBD has remained a minor topic, primarily of interest in limitedcontexts, such as currency boards. It is generally held in ill repute today, with Frederic Mishkin,a governor of the Federal Reserve going so far as to say it had been "completely discredited."Even so, it has theoretical support from a few economists, particularly those that see restrictionson a particular class of credit as incompatible with libertarian principles of laissez-faire, eventhough almost all libertarian economists are opposed to the RBD.

The debate between currency, or quantity theory, and banking schools in Britain during the 19thcentury prefigures current questions about the credibility of money in the present. In the 19thcentury the banking school had greater influence in policy in the United States and GreatBritain, while the currency school had more influence "on the continent", that is in non-Britishcountries, particularly in the Latin Monetary Union and the earlier Scandinavia monetary union.

Anti-classicalorbackingtheory

Another issue associated with classical political economy is the anti-classical hypothesis ofmoney, or "backing theory". The backing theory argues that the value of money is determinedby the assets and liabilities of the issuing agency. [52] Unlike the Quantity Theory of classicalpolitical economy, the backing theory argues that issuing authorities can issue money withoutcausing inflation so long as the money issuer has sufficient assets to cover redemptions. Thereare very few backing theorists, making quantity theory the dominant theory explaining inflation.

Controlling inflation

A variety of methods have been used in attempts to control inflation.

Monetary policy


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The U.S. effective federal funds rate charted over fifty years.

Today the primary tool for controlling inflation is monetary policy. Most central banks are taskedwith keeping the federal funds lending rate at a low level, normally to a target rate around 2% to3% per annum, and within a targeted low inflation range, somewhere from about 2% to 6% perannum. A low positive inflation is usually targeted, as deflationary conditions are seen asdangerous for the health of the economy.

There are a number of methods that have been suggested to control inflation. Central bankssuch as the U.S. Federal Reserve can affect inflation to a significant extent through settinginterest rates and through other operations. High interest rates and slow growth of the moneysupply are the traditional ways through which central banks fight or prevent inflation, thoughthey have different approaches. For instance, some follow a symmetrical inflation target whileothers only control inflation when it rises above a target, whether express or implied.

Monetarists emphasize keeping the growth rate of money steady, and using monetary policy tocontrol inflation (increasing interest rates, slowing the rise in the money supply). Keynesiansemphasize reducing aggregate demand during economic expansions and increasing demandduring recessions to keep inflation stable. Control of aggregate demand can be achieved usingboth monetary policy and fiscal policy (increased taxation or reduced government spending toreduce demand).

Fixed exchange rate

Under a fixed exchange rate currency regime, a country's currency is tied in value to anothersingle currency or to a basket of other currencies (or sometimes to another measure of value,such as gold). A fixed exchange rate is usually used to stabilize the value of a currency, vis-a-vis the currency it is pegged to. It can also be used as a means to control inflation. However, asthe value of the reference currency rises and falls, so does the currency pegged to it. Thisessentially means that the inflation rate in the fixed exchange rate country is determined by theinflation rate of the country the currency is pegged to. In addition, a fixed exchange rateprevents a government from using domestic monetary policy in order to achieve

macroeconomic stability.Under the Bretton Woods agreement, most countries around the world had currencies that werefixed to the US dollar. This limited inflation in those countries, but also exposed them to thedanger of speculative attacks. After the Bretton Woods agreement broke down in the early1970s, countries gradually turned to floating exchange rates. However, in the later part of the20th century, some countries reverted to a fixed exchange rate as part of an attempt to controlinflation. This policy of using a fixed exchange rate to control inflation was used in many


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countries in South America in the later part of the 20th century (e.g. Argentina (1991-2002),Bolivia, Brazil, and Chile).

Gold standard

Under a gold standard, paper notes are convertible into pre-set, fixed quantities of gold.

The gold standard is a monetary system in which a region's common media of exchange arepaper notes that are normally freely convertible into pre-set, fixed quantities of gold. Thestandard specifies how the gold backing would be implemented, including the amount of specieper currency unit. The currency itself has no innate value, but is accepted by traders because itcan be redeemed for the equivalent specie. A U.S. silver certificate, for example, could beredeemed for an actual piece of silver.

The gold standard was partially abandoned via the international adoption of the Bretton WoodsSystem. Under this system all other major currencies were tied at fixed rates to the dollar, whichitself was tied to gold at the rate of $35 per ounce. The Bretton Woods system broke down in1971, causing most countries to switch to fiat money money backed only by the laws of thecountry. Austrian economists strongly favor a return to a 100 percent gold standard.

Under a gold standard, the long term rate of inflation (or deflation) would be determined by thegrowth rate of the supply of gold relative to total output. [53] Critics argue that this will causearbitrary fluctuations in the inflation rate, and that monetary policy would essentially bedetermined by gold mining,[54][55] which some believe contributed to the Great Depression.

Incomes policies

Another method attempted in the past have been wage and price controls ("incomes policies").Wage and price controls have been successful in wartime environments in combination withrationing. However, their use in other contexts is far more mixed. Notable failures of their useinclude the 1972 imposition of wage and price controls by Richard Nixon. More successfulexamples include the Prices and Incomes Accord in Australia and the Wassenaar Agreement inthe Netherlands.

In general wage and price controls are regarded as a temporary and exceptional measure, onlyeffective when coupled with policies designed to reduce the underlying causes of inflation duringthe wage and price control regime, for example, winning the war being fought. They often haveperverse effects, due to the distorted signals they send to the market. Artificially low prices oftencause rationing and shortages and discourage future investment, resulting in yet further


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shortages. The usual economic analysis is that any product or service that is under-priced isoverconsumed. For example, if the official price of bread is too low, there will be too little breadat official prices, and too little investment in bread making by the market to satisfy future needs,thereby exacerbating the problem in the long term.

Temporary controls may complementa recession as a way to fight inflation: the controls make

the recession more efficient as a way to fight inflation (reducing the need to increaseunemployment), while the recession prevents the kinds of distortions that controls cause whendemand is high. However, in general the advice of economists is not to impose price controlsbut to liberalize prices by assuming that the economy will adjust and abandon unprofitableeconomic activity. The lower activity will place fewer demands on whatever commodities weredriving inflation, whether labor or resources, and inflation will fall with total economic output.This often produces a severe recession, as productive capacity is reallocated and is thus oftenvery unpopular with the people whose livelihoods are destroyed (see creative destruction).

Cost of living.

The real purchasing-power of fixed payments is eroded by inflation unless they are inflation-adjusted to keep their real values constant. In many countries, employment contracts, pensionbenefits, and government entitlements (such as social security) are tied to a cost-of-living index,typically to the consumer price index.[58] A cost-of-living allowance (COLA) adjusts salariesbased on changes in a cost-of-living index. Salaries are typically adjusted annually in lowinflation economies. During hyperinflation they are adjusted more often. [58] They may also betied to a cost-of-living index that varies by geographic location if the employee moves.

Annual escalation clauses in employment contracts can specify retroactive or future percentageincreases in worker pay which are not tied to any index. These negotiated increases in pay arecolloquially referred to as cost-of-living adjustments or cost-of-living increases because of theirsimilarity to increases tied to externally determined indexes. Many economists andcompensation analysts consider the idea of predetermined future "cost of living increases" to bemisleading for two reasons: (1) For most recent periods in the industrialized world, averagewages have increased faster than most calculated cost-of-living indexes, reflecting the influenceof rising productivity and worker bargaining power rather than simply living costs, and (2) mostcost-of-living indexes are not forward-looking, but instead compare current or historical data.

Howdo interestrates affect inflation?

WSA adsense code -->

John commented on a previous post about the importance of the Bank of Englands interestrates:

I suggest you write an article about how interest rates effect inflation and vice versa. Somethingpractical for the masses.

It sounded like a good idea to me, so here goes:

Supplyanddemand in pancakes, oranythingelse


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Imagine people selling pancakes. If there is a big demand for pancakes, but there arent manypeople supplying pancakes then the prices will go up as the customers outbid each other forpancakes. If there is a big supply of pancakes, and not a lot of people demanding pancakes,then the price of pancakes will go down as the pancake sellers undercut each other.

Now what is true for pancakes is also true for the relationship between money and prices. If

there is more money than there are goods and services to buy, then the prices for the goodsand services will go up. If there is less money than there are goods and services to buy, thenthe prices for the goods and services will go down. The measurement of the change in pricesover time (the rate at which prices change) is inflation.

the priceofmoney

This is where interest rates come in. One of the ways that you can think about interestrates, isas the price of money. If you look at something like zopa* or prosper*, you get borrowers sayinghow much interest theyre willing to pay (what price are they willing to pay for money) and youget lenders saying how much interest they want to charge (what price are they willing to sellmoney for).

As Ive explained before the interest rate, or the price of money overall, in a currency iseffectively determined by the central bank - such as the Bank of England, the European CentralBank or the Federal Reserve for example. This means that if the central banks interest ratesare high, money is more expensive, and if the central banks interest rates are low, then moneyis cheaper.

bringing italltogether

As with all things, if money is expensive then it will tend to be in short supply, and if money ischeap it will tend to be in plentiful supply. But as we saw before, if money is in short supply

[interest rates are high] then prices overall will go down [inflation is low or negative], and ifmoney is in plentiful supply [interest rates are low] then prices overall will go up [inflation ishigh].

This is whyhigherinterestrates tendtoleadtolower inflation;andlower interestratestendtoleadtohigherinflation.

*these are affiliate links, regular links are zopa and prosper

SimilarPosts:

y what is the Bank of England base rate and why is it important?y thinking about deflationy what do you assume?

If you like what you're reading, why not leave a comment below, subscribe to my feed, or check

out some of my best posts.

Discussion


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18comments forhowdo interestrates affect inflation?

1. I like how you put them all together. Obviously, supply and demand arent always inperfect balance with each other, but understanding the concepts is a good start.(speaking of supply and demand, my boss was just wondering why anybody would putRed Delicious apples in a gift basket. We decided that since they werent popular (in ouropinions), they were probably cheaper).

Posted by Mrs. Micah | November 27, 2007, 4:13 pm

2. This is the standard explanation given out by economists. However, if you have not beentaught this and you looked at it rationally then, surely, higher interest rates charged bythe banks actually leads to higher prices. Why? Because the producers of the goods andservices, who borrow the money from the banks, have higher costs associated withservicing those loans used in producing the goods and services. And because theproducers are in the business of making profit then they have to pass on to theconsumer the additional higher costs in the prices charged for the goods and services.

So higher interest rates must lead to higher prices (or inflation, if you want to call it that)

Posted byRussell | November 28, 2007, 9:55 am

3. like ur article but you missed out the point where it all goes wrong that is.. when theinterest rates are increased to decrease inflation but the high cost of borrowing forbusinesses & sellers is passed on to the customers resulting in inflation after all

Posted by Mr. A.Wasae Shaikh | April 15, 2008, 12:02 pm

4. sir i have liked your article but i cant understand that consumption of basic goods likevegetable does not depend on money inflow in market ie even if it goes cheaper peoplewont consume more than normal level then how money inflow in market will affect theirprises

Posted by shyam | July 9, 2008, 10:34 am

5. I was an economics major and I have never heard the relationship or interest rates,inflation and supply of money explained so well.

Posted by chris | July 13, 2008, 7:57 pm

6. While the central bank sets the rate at which banks can borrow from it they dont set

interest rates. The central banks actions often have quite a large influence on short terminterest rates. Long term interest rates however, are much less controllable, and whileaffected by they central banks decisions, often have the opposite effect that people think(the central bank lowering the short term rates at which banks can borrow stoke fears ofinflation and can actually result in increased long term rates).

Posted byCurious Cat Investing Blog | July 14, 2008, 2:52 pm


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7. @curious cat:I agree that the effect on high street rates can be masked by other factors, and that longterm rates move differently compared to short term rates. However, in the UK mostpeople dont have long term fixed mortgages or loans, so its reasonably likely thatchanges in the Bank of Englands interest rates will affect high street rates.

Unless of course your in a credit crunch but then, its still the money supply that effectshigh street rates, simply that the people with the money are hoarding it rather thanlending it out. I think.

Posted by plonkee | July 14, 2008, 6:17 pm

8. I agree with russell nov 28 and add that as well as causing inflation an increase ininterest rates causes an increase in exchange rate and an outflow of money throughcheapened importsPlonkees explanation/theory only works in a closed economyThe real cause of inflation is an increase in govt regulation making it more difficult to

enter an industry ,reducing competition and increasing costs.Posted by garth | July 21, 2008, 8:39 am

9. I really appreciate the article as it theoritacally clearifies the concept retated with interestand inflation. But in the practical world how far is it applicable since people cannot lowertheir demand of basic needs even if they dont have enough money and the producerswill surely pass their increased cost of production on to the consumers resulting in areverse effect.

Posted by Himel | September 19, 2008, 7:00 am

10. Good work with this explanation Plonkee. It might be an interesting idea to do a newversion for what happens if we get zero interest rates (i.e. look into real interest rates).We could be going that way, after all, and thats even harder to explain than normalinterest rates and inflation

Treasury Inflation-Protected Securities, orTIPS, have been battling inflation in portfoliossince1997. You can buythis protection intheformofan individual bond, anexchange-tradedfundoramutualfund.

The Treasury Department uses the Consumer Price Index, or CPI, as a guide to adjust theprincipal for inflation on a semiannual basis. A fixed interest rate is paid semiannually on theadjusted principal.

For example, if you buy a $10,000 bond with an interest rate of 2 percent but inflation equals 3percent that year, the face value of the bond will be increased by $300 to $10,300 and the 2percent interest rate will be applied to the new face value. So, what happens if you own thebond in a deflationary environment? The principal will be adjusted downward, but as long as youhold until maturity you'll receive your original investment.


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TIPS bonds are meant to be long-term investments. There is a secondary market, meaning youcan sell your bond before maturity, but as mentioned, you won't receive your full principalinvestment if you've owned the bond during a deflationary period.

Individual bonds

Newly issued TIPS bonds are bought at Treasury auctions through the government Web siteTreasuryDirect.gov or through a broker. The bond's yield is determined at auction. Somebrokers don't charge a fee for Treasury auction orders placed online, but do charge if you needthe services of a representative. There is no fee when buying through TreasuryDirect.

TIPS are issued in maturities of five, 10 and 20 years. They are auctioned during specificmonths according to their maturity. Five-year TIPS are auctioned in April and October; 10-yearTIPS in January, April, July and October; and the 20-year in January and July.

There are two ways to participate in the auctions. By far, most individuals place anoncompetitive bid. As such, you agree to the yield determined at auction. You can also place a

competitive bid where you state the yield you're willing to accept. If you go the noncompetitiveroute, you'll likely get a better rate because you're essentially going along for the ride with themoney managers who can demand a better rate because they're spending millions at theauction.

If you prefer to place a competitive bid, you'll have to do it through a broker becauseTreasuryDirect doesn't accept competitive bids from individuals.

Not long ago, the minimum purchase price for a TIPS bond was $1,000, with additionalpurchases in increments of $1,000. But that rule has been changed and you can now buy aTIPS bond for as little as $100, with additional purchases in increments of $100. The limit for asingle auction with a noncompetitive bid is $5 million.

Interest and principal growth in TIPS are subject to federal tax, but exempt from state and localtaxes. While tax on interest may be deferred until the bond is redeemed, tax on any principalincrease is due the year in which it's gained even though you don't receive the inflation-adjustedprincipal until the bond matures. If possible, hold TIPS in a tax-deferred account or, better yet, aRoth IRA.

TIPS are sold only in electronic form.

Also consider the government's inflation-fighting savings bond, the I bond, when looking forfixed-rate inflation protection.

Exchange-tradedfunds andmutualfunds

If a long-term commitment to a bond isn't right for you but you'd still like to tap into someinflation protection, exchange-traded funds or mutual funds are options.

A major difference between a bond and an ETF or a mutual fund is that the bond comes with aguarantee that you will receive your full principal if you hold the bond until maturity. While the


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underlying bonds in an ETF or mutual fund have maturity dates, the fund itself does not. Whatyou get depends on when you sell your shares.

Bankrate isn't in the business of recommending specific stocks, ETFs or mutual funds, but someof the more popular anti-inflation ETFs are iShares Lehman TIPS Bond (TIP), SPDR BarclaysCapital TIPS (IPE) and SPDR DB International Government Inflation-Protected Bond (WIP).

TIP and IPE hold U.S. Treasury inflation-protected bonds while WIP focuses on inflation-fightingbonds issued by foreign governments.

There are scores of mutual funds that offer inflation protection. Again, here are a few widelypopular funds to consider researching: Vanguard Inflation-Protected Securities (VIPSX), FidelityInflation-Protected Bond Fund (FINPX), T. Rowe Price Inflation-Protected Bond Fund (PRIPX),and Schwab Inflation-Protected Fund (SWRSX).

Not all inflation-protected funds invest solely in government inflation bonds. Some may invest asmall portion of the portfolio in corporate bonds in an effort to boost returns. Be sure to exploreall of the details before buying.

20072008worldfood pricecrisis

From Wikipedia, the free encyclopedia

Jump to: navigation, search

Chart of global trade volume in wheat, coarse grain and soybeans 1990 to 2008, and projectedto 2016. United States Department of Agriculture, 2008.


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Chart of the United States stock to use ratio of soybeans, maize and wheat, from 1977 to 2007,and projected to 2016. United States Department of Agriculture, September 2007.

The years 20072008 saw dramatic increases in world food prices, creating a global crisis andcausing political and economical instability and social unrest in both poor and developednations.

Systemic causes for the worldwide increases in food prices continue to be the subject of debate.Initial causes of the late 2006 price spikes included droughts in grain-producing nations andrising oil prices. Oil price increases also caused general escalations in the costs of fertilizers,food transportation, and industrial agriculture. Root causes may be the increasing use ofbiofuels in developed countries (see also food vs fuel),[1] and an increasing demand for a morevaried diet across the expanding middle-class populations of Asia.[2][3] These factors, coupledwith falling world-food stockpiles all contributed to the worldwide rise in food prices.[4] Causesnot commonly attributed by mainstream views include structural changes in trade andagricultural production, agricultural price supports and subsidies in developed nations,diversions of food commodities to high input foods and fuel, commodity market speculation, andclimate change.

Drastic price increases

Between 2006 and 2008 average world prices for rice rose by 217%, wheat by 136%, corn by125% and soybeans by 107%.[5] In late April 2008 rice prices hit 24 cents (U.S.) per U.S. pound,more than doubling the price in just seven months.[6]

[edit]World populationgrowth

Growth in food production has been greater than population growth. Food per person increasedduring the 19612005 period.


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Although some commentators have argued that this food crisis stems from unprecedentedglobal population growth,[7][8] others point out that world population growth rates have droppeddramatically since the 1980s,[9][10] and grain availability has continued to outpace population.However, despite production gains made in the last decade, world food demand outpaces anyproduction increases. According to Joachim von Braun, of the IFPRI, total food productionincreases only about 1 to 2 percent per year, while total world population increases

approximately 4%.[11][12] Aggregate cereal grain food production, per capita, had risen yearlyfrom the 1960s to the 1980s but has been in decline since. [13] However, this does not take intoaccount any non-food uses of grain production.

World population has grown from 1.6 billion in 1900 to an estimated 6.8 billion [3].

[edit] Increaseddemandformoreresource intensivefood

The head of the International Food Policy Research Institute, stated in 2008 that the gradualchange in diet among newly prosperous populations is the most important factor underpinningthe rise in global food prices.[14] Where food utilization has increased, it has largely been inprocessed ("value added") foods, sold in developing and developed nations.[15] Total grainutilization growth since 2006 (up three percent, over the 20002006 per annum average of twopercent) has been greatest in non-food usage, especially in feed and biofuels. [16][17] Onekilogram of beef requires seven kilograms of feed grain.[18] These reports, therefore, concludethat usage in industrial, feed, and input intensive foods, not population growth among poorconsumers of simple grains, has contributed to the price increases.

2005/1990 ratios of per capita consumption[19]

India China Brazil Nigeria

Cereals 1.0 0.8 1.2 1.0

Meat 1.2 2.4 1.7 1.0

Milk 1.2 3.0 1.2 1.3

Fish 1.2 2.3 0.9 0.8

Fruits 1.3 3.5 0.8 1.1

Vegetables 1.3 2.9 1.3 1.3

Although the vast majority of the population in Asia remains rural and poor, the growth of themiddle class in the region has been dramatic. For comparison, in 1990, the middle class grewby 9.7 percent in India and 8.6 percent in China, but by 2007 the growth rate was nearly 30percent and 70 percent respectively.[4] The corresponding increase in Asian affluence alsobrought with it a change in lifestyle and eating habits, particularly a demand for greater variety,


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leading to increased competition with western nations for already strained agriculturalresources.[20][21] This demand exacerbates dramatic increases in commodity prices such as oil.

Another issue was rising affluence in India and China was reducing the 'shock absorber' of poorpeople who are forced to reduce their resource consumption when food prices rise. Thisreduced price elasticity and caused a sharp rise in food prices during some shortages. In the

media, China is often mentioned as one of the main reasons for the increase in world foodprices. However, China has to a large extent been able to meet its own demand for food, andeven exports its surpluses in the world market.[22]

[edit] Effects ofpetroleum price increases

The rise in the price of oil has heightened the costs of fertilizers (in some instances doubling theprice within the six months before April, 2008[23]), the majority of which require petroleum ornatural gas to manufacture.[4] Although the main fossil fuel input for fertilizer comes from naturalgas to generate hydrogen for the HaberBosch process (see: Ammonia production), natural gashas its own supply problems similar to those for oil. Because natural gas can substitute forpetroleum in some uses (for example, natural gas liquids and electricity generation), increasingprices for petroleum lead to increasing prices for natural gas, and thus for fertilizer.

Costs for fertilizer raw materials other than oil, such as potash, have themselves beenincreasing[24] as increased production of staples increases demand. This is causing a boom(with associated volatility) in agriculture stocks.

[edit] Decliningworldfood stockpiles

In the past, nations tended to keep more sizable food stockpiles, but more recently, due to afaster pace of food growth and ease of importation, less emphasis is placed on high stockpiles.For example, in February 2008 wheat stockpiles hit a 60-year low in the United States (see also

Rice shortage).[4]

Data stocks are often calculated as a residual between Production andConsumption but it becomes difficult to discriminate between a destocking policy choices ofindividual countries and a deficit between production and consumption.

[edit] Financial speculation

Destabilizing influences, including indiscriminate lending and real estate speculation, led to acrisis in January 2008, and eroded investment in food commodities.[4] The United States,specifically, had been facing an economic crisis that eventually lead to recession.[25][26][27]

Financial speculation in commodity futures following the collapse of the financial derivativesmarkets has contributed to the crisis due to a "commodities super-cycle." Financial speculatorsseeking quick returns have removed trillions of dollars from equities and mortgage bonds, someof which has been invested into food and raw materials.[28] That American commoditiesspeculation could have a worldwide effect on food prices is reflected in the globalization of foodproduction. It represents the concentration of wealth throughout the world, which Frances MooreLapp equates to a weakening in fundamental democracy. In a recent article forThe Nation,she suggests that there is no food shortage but that "as long as food is merely a commodity insocieties that don't protect people's right to participate in the market, and as long as farming is


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left vulnerable to consolidated power off the farm, many will go hungry, farmers among themno matter how big the harvests."[29]

[edit]CommodityIndexFunds

A 2010 article in Harper's by Frederick Kaufman alleged that these Commodity Index funds(invented by Goldman Sachs) were part of the global food crisis in 2008, including riots in 30countries, a food price rise of 80 percent between 2005 and 2008, and an increased hungerrate. The article claimed that one mechanism involved was a 'demand shock' on wheat futurescaused by the index funds, resulting in a 'contango' wheat market on the Chicago MercantileExchange. This all caused prices of wheat to rise much higher than normal, defeating thepurpose of the exchanges (price stabilization) in the first place.[30]

[edit] Effects oftradeliberalization

Some theorists, such as Martin Khor of the Third World Network, [31] point out that manydeveloping nations have gone from being food independent to being net food importing

economies since the 1970s and 1980s International Monetary Fund (and later the World TradeOrganisation's Agreement on Agriculture) free market economics directives to debtor nations. Inopening developing countries to developed world food imports subsidised by Westerngovernments, developing nations have become dependent upon food imports that are cheaperthan what local smallholders agriculture produces, even in the poorest regions of the world. [31]

While developed countries pressured the developing world to abolish subsidies in the interest oftrade liberalization, rich countries largely kept subsidies in place for their own farmers. In recentyears United States government subsidies have been added to push production toward biofuelrather than food and vegetables .[4]

[edit] Effects offoodforfuel

Main article: Food vs fuel

One systemic cause for the price rise is held to be the diversion of food crops (maize inparticular) for making first-generation biofuels.[32] An estimated 100 million tons of grain per yearare being redirected from food to fuel.[33] (Total worldwide grain production for 2007 was justover 2000 million tonnes.[34]) As farmers devoted larger parts of their crops to fuel productionthan in previous years, land and resources available for food production were reducedcorrespondingly. This has resulted in less food available for human consumption, especially indeveloping and least developed countries, where a family's daily allowances for food purchasesare extremely limited. The crisis can be seen, in a sense, to dichotomize rich and poor nations,since, for example, filling a tank of an average car with biofuel, amounts to as much maize(Africa's principal food staple) as an African person consumes in an entire year. [4]

Brazil, the world's second largest producer of ethanol after the U.S., is considered to have theworld's first sustainable biofuels economy[35][36][37] and its government claims Brazil's sugar canebased ethanol industry has not contributed to the 2008 food crises. [37][38] A World Bank policyresearch working paper released in July 2008[39] concluded that "...large increases in biofuelsproduction in the United States and Europe are the main reason behind the steep rise in globalfood prices", and also stated that "Brazil's sugar-based ethanol did not push food pricesappreciably higher".[40][41] An economic assessment published in July 2008 by the OECD[42]


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disagrees with the World Bank report regarding the negative effects of subsidies and traderestrictions, finding that the effect of biofuels on food prices are much smaller.[43]

A report released by Oxfam in June 2008[44] criticized biofuel policies of rich countries andconcluded that from all biofuels available in the market, Brazilian sugarcane ethanol is "far fromperfect" but it is the most favorable biofuel in the world in term of cost and GHG balance. The

report discusses some existing problems and potential risks, and asks the Brazilian governmentfor caution to avoid jeopardazing its environmental and social sustainability. The report alsosays that: "Rich countries spent up to $15 billion last year supporting biofuels while blockingcheaper Brazilian ethanol, which is far less damaging for global food security."[45][46] (SeeEthanol fuel in Brazil)

German Chancellor Angela Merkel said the rise in food prices is due to poor agricultural policiesand changing eating habits in developing nations, not biofuels as some critics claim. [47] On April29, 2008, U.S. President George W. Bush declared during a press conference that "85 percentof the world's food prices are caused by weather, increased demand and energy prices", andrecognized that "15 percent has been caused by ethanol".[48] On July 4, 2008, The Guardianreported that a leaked World Bank report estimated the rise in food prices caused by biofuels to

be 75%.[49] This report was officially released in July 2008.[39]

Since reaching record high prices in June 2008, corn prices fell 50% by October 2008, decliningsharply together with other commodities, including oil. As ethanol production from corn hascontinue at the same levels, some have argued this trend shows the belief that the increaseddemand for corn to produce ethanol was mistaken. "Analysts, including some in the ethanolsector, say ethanol demand adds about 75 cents to $1.00 per bushel to the price of corn, as arule of thumb. Other analysts say it adds around 20 percent, or just under 80 cents per bushel atcurrent prices. Those estimates hint that $4 per bushel corn might be priced at only $3 withoutdemand for ethanol fuel."[50] These industry sources consider that a speculative bubble in thecommodity markets holding positions in corn futures was the main driver behind the observedhike in corn prices affecting food supply.

Second- and third-generation biofuels (such as cellulosic ethanol and algae fuel, respectively)may someday ease the competition with food crops, as non food energy crops can grow onmarginal lands unsuited for food crops, but these advanced biofuels require further developmentof farming practices and refining technology; in contrast, ethanol from maize uses maturetechnology and the maize crop can be shifted between food and fuel use quickly.

[edit] Biofuel subsidies inthe US andthe EU

The World Bank lists the effect of biofuels as an important contributor to higher food prices.[51]The FAO/ECMB has reported that world land usage for agriculture has declined since the

1980s, and subsidies outside the United States and EU have dropped since the year 2004,leaving supply, while sufficient to meet 2004 needs, vulnerable when the United States beganconverting agricultural commodities to biofuels.[52] According to the United States Department of

Agriculture, global wheat imports and stocks have decreased, domestic consumption hasstagnated, and world wheat production has decreased from 2006 to 2008.[53]

In the United States, government subsidies for ethanol production have prompted many farmersto switch to production for biofuel. Maize is the primary crop used for the production of ethanol,with the United States being the biggest producer of maize ethanol. As a result, 23 percent of


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United States maize crops were being used for ethanol in 20062007 (up from 6 percent in20052006), and the USDA expects the United States to use 81 million tonnes of maize forethanol production in the 20072008 season, up 37 percent.[54] This not only diverts grains fromfood, but it diverts agricultural land from food production.

Nevertheless, supporters of ethanol claim that using corn for ethanol is not responsible for the

worst food riots in the world, many of which have been caused by the price of rice and oil, whichare not affected by biofuel use but rather by supply and demand.

However, a World Bank policy research working paper released in July 2008 [39] says thatbiofuels have raised food prices between 70 to 75 percent. The study found that higher oilprices and a weak dollar explain 2530% of total price rise. The "month-by-month" five yearanalysis disputes that increases in global grain consumption and droughts were responsible forprice increases, reporting that this had had only a marginal effect and instead argues that theEU and US drive for biofuels has had by far the biggest effect on food supply and prices. Thepaper concludes that increased production of biofuels in the US and EU were supported bysubsidies and tariffs on imports, and considers that without these policies, price increases wouldhave been smaller. This research also concluded that Brazil's sugar cane based ethanol has not

raised sugar prices significantly, and suggest to remove tariffs on ethanol imports by both theUS and EU, to allow more efficient producers such as Brazil and other developing countries toproduce ethanol profitably for export to meet the mandates in the EU and the US.[40][41]

The Renewable Fuel Association (RFA) published a rebuttal based on the version leaked beforethe formal release of the World Bank's paper.[55] The RFA critique considers that the analysis ishighly subjective and that the author "estimates the effect of global food prices from the weakdollar and the direct and indirect effect of high petroleum prices and attributes everything else tobiofuels."[56]

An economic assessment report also published in July 2008 by the OECD[42] agrees with theWorld Bank report regarding the negative effects of subsidies and trade restrictions, but foundthat the effect of biofuels on food prices are much smaller. The OECD study is also critical of thelimited reduction of GHG emissions achieved from biofuels produced in Europe and North

America, concluding that the current biofuel support policies would reduce greenhouse gasemissions from transport fuel by no more than 0.8 percent by 2015, while Brazilian ethanol fromsugar cane reduces greenhouse gas emissions by at least 80 percent compared to fossil fuels.The assessment calls on governments for more open markets in biofuels and feedstocks toimprove efficiency and lower costs.[43]

[edit] Idledfarmland

According to the New York Times on April 9, 2008, the United States government pays farmers

to idle their cropland under a conservation program. This policy reached a peak of36,800,000 acres (149,000 km2) idled in 2007, that is 8% of cropland in United States,representing a total area bigger than the state of New York.[57]

[edit] Agricultural subsidies

The global food crisis has renewed calls for removal of distorting agricultural subsidies indeveloped countries.[58] Support to farmers in OECD countries totals 280 billion USD annually,which compares to official development assistance of just 80 billion USD in 2004, and farm


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support distorts food prices leading to higher global food prices, according to OECDestimates.[59] The US Farm Bill brought in by the Bush Administration in 2002 increasedagricultural subsidies by 80% and cost the US taxpayer 190 billion USD. [60] In 2003, the EUagreed to extend the Common Agricultural Policy until 2013. Former UNDP AdministratorMalloch Brown renewed calls for reform of the farm subsidies such as the CAP. [61]

[edit] Distortedglobalricemarket

Japan is forced to import more than 767,000 tons of rice annually from the United States,Thailand, and other countries due to WTO rules.[62] This is despite the fact that Japan producesover 100% of domestic rice consumption needs with 11 million tonnes produced in 2005 while8.7 million tonnes were consumed in 20032004 period. [citation needed] Japan is not allowed to re-export this rice to other countries without approval. This rice is generally left to rot and then usedfor animal feed. Under pressure, the United States and Japan are poised to strike a deal toremove such restrictions. It is expected 1.5 million tonnes of high-grade American rice will enterthe market soon.[63]

[edit] Crop shortfalls fromnaturaldisasters

Several distinct weather- and climate-related incidents have caused disruptions in cropproduction. Perhaps the most influential is the extended drought in Australia, in particular thefertile Murray-Darling Basin, which produces large amounts of wheat and rice. The drought hascaused the annual rice harvest to fall by as much as 98% from pre-drought levels.[64] Australia ishistorically the second-largest exporter of wheat after the United States, producing up to 25million tons in a good year, the vast majority for export. However, the 2006 harvest was 9.8million.[65] Other events that have negatively affected the price of food include the 2006 heatwave in California's San Joaquin Valley, which killed large numbers of farm animals, andunseasonable 2008 rains in Kerala, India, which destroyed swathes of grain. Scientists havestated that several of these incidents are consistent with the predicted effects of climate

change.[66][67]

The effects of Cyclone Nargis on Burma in May 2008 caused a spike in the price of rice. Burmahas historically been a rice exporter, though yields have fallen as government price controlshave reduced incentives for farmers. The storm surge inundated rice paddies up to 30 miles(48 km) inland in the Irrawaddy Delta, raising concern that the salt could make the fieldsinfertile. The FAO had previously estimated that Burma would export up to 600,000 tons of ricein 2008, but concerns were raised in the cyclone's aftermath that Burma may be forced to importrice for the first time, putting further upward pressure on global rice prices.[6][68]

Stem rust reappeared in 1998[69] in Uganda (and possibly earlier in Kenya)[70] with theparticularly virulent UG99 fungus. Unlike other rusts, which only partially affect crop yields,

UG99 can bring 100% crop loss. Up to 80% yield losses were recently recorded in Kenya.[71]

Asof 2005 stem rust was still believed to be "largely under control worldwide except in EasternAfrica".[70] But by January 2007 an even more virulent strain had gone across the Red Sea intoYemen. FAO first reported on 5 March 2008 that Ug99 had now spread to major wheat-growingareas in Iran.[72] These countries in North Africa and Middle East consume over 150% of theirown wheat production;[69] the failure of this staple crop thus adds a major burden on them. Thedisease is now expected to spread over China and the Far-East. The strong internationalcollaboration network of research and development that spread disease-resistant strains some


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40 years ago and started the Green Revolution, was since slowly starved of research fundsbecause of its own success and is now too atrophied to swiftly react to the new threat.[69]

[edit] Soiland productivitylosses

Sundquist [73] points out that large areas of croplands are lost year after year, due mainly to soilerosion, water depletion and urbanisation. According to him "60,000 km2/ year of land becomesso severely degraded that it loses its productive capacity and becomes wasteland", and evenmore are affected to a lesser extent, adding to the crop supply problem.

Additionally, agricultural production is also lost due to water depletion. Northern China inparticular has depleted much of its non-renewables aquifers, which now impacts negatively itscrop production.[74]

Urbanisation is another, smaller, difficult to estimate cause of annual cropland reduction. [75]

[edit] Risinglevels ofozone

One possible environmental factor in the food price crisis is rising background levels of ozone inthe atmosphere. Plants have been shown to have a high sensitivity to ozone levels, and loweryields of important food crops, such as wheat and soybeans, may have be a result of ozonelevels. Ozone levels in the Yangtze Delta were studied for their effect on oilseed rape, amember of the cabbage family that produces one-third of the vegetable oil used in China. Plantsgrown in chambers that controlled ozone levels exhibited a 1020 percent reduction in size andweight (biomass) when exposed to elevated ozone. Production of seeds and oil was alsoreduced.[76]

[edit] Rising prices

From the beginning of 2007 to early 2008, the prices of some of the most basic internationalfood commodities increased dramatically on international markets. The international marketprice of wheat doubled from February 2007 to February 2008 hitting a record high of overUSD$10 a bushel.[77] Rice prices also reached ten year highs. In some nations, milk and meatprices more than doubled, while soy (which hit a 34 year high price in December 2007 [78]) andmaize prices have increased dramatically.

Total food import bills rose by an estimated 25% for developing countries in 2007. Researchersfrom the Overseas Development Institute have suggested this problem will be worsened by alikely fall in food aid. As food aid is programmed by budget rather than volume, rising foodprices mean that the World Food Programme (WFP) needs an extra $500 million just to sustainthe current operations.[79]

To ensure that food remains available for their domestic populations and to combat dramaticprice inflation, major rice exporters, such as China, Brazil, India, Indonesia, Vietnam, Cambodiaand Egypt, have imposed strict export bans on rice. [80] Conversely, several other nations,including Argentina, Ukraine, Russia, and Serbia have, as well, either imposed high tariffs orblocked the export of wheat and other foodstuffs altogether, driving up prices still further for netfood importing nations while trying to isolate their internal markets. Finally, North Korea, is alsosuffering from the food crisis (to such extent that a North Korean official was quoted in June '08


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with saying "Life is more than difficult. It seems that everyone is going to die"). [81] This nationhowever is solely relying on food assistance to cope with the crisis. [82]

[edit] Indevelopedcountries

This section requires expansion.

[edit]UnitedStates

The global food price crisis has appeared in the U.S.A. as the rice shortage [citation needed]. Theretail prices of food in the U.S. increased four percent according to the Consumer Price Index in2007, the largest increase in 17 years. The USDA Economic Research Service predicted thatprices would increase another three to four percentage points throughout 2008. [83]

In April 2008 Sam's Club instituted a limit on how much long-grain white rice that restaurant and

retail customers could purchase due to shortages. Purchases of other types of rice were notrestricted.[84][85] A May 2008 national survey found that food banks and pantries across the U.S.were being forced to cut back on food distribution as 99 percent of respondents reported anincrease in the number of people requesting services. Rising food and fuel prices, inadequatefood stamp benefits, unemployment, underemployment, and rent or mortgage costs werefactors reported as forcing an average of 15-20 percent more people. [86] Compounding thisissue, USDA bonus foods have declined by $200 million and local food donations were downnationally about 9 percent over the same period. According to the California Association of FoodBanks, which is an umbrella organization of nearly all food banks in the state, food banks are atthe "beginning of a crisis."[87]

[edit] Effects onfarmers

If global price movements are transmitted to local markets, farmers in the developing worldcould benefit from the rising price of food. According to researchers from the OverseasDevelopment Institute, this may depend on farmers capacity to respond to changing marketconditions. Experience suggests that farmers lack the credit and inputs needed to respond inthe short term. In the medium or long term, however, they could benefit, as seen in the Asiangreen revolution or in many African countries in the recent past. [79]

[edit] Unrestandgovernmentactions in individualcountries andregions

The price rises affect

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