The following article deals with the topic “The Future of Central Banking: Inflation Targeting vs. Financial Stability,” which will be discussed at the Global Economic Symposium in Rio this October. The author intends to enrich the discussion at the symposium with his personal stories and ideas.
After an 18-month reprieve, world food prices are on the rise again. The Food Price Index from the Food and Agriculture Organization of the United Nations (FAO) went up by more than 6% in July, with the Cereals sub-index surging 17% in that month. Corn and soya recently hit all-time highs in nominal terms.
Apart from the obvious and potentially disruptive social effects, rising food prices pose a challenge to the central banks of developing countries. In most of them, food is the most important component of the consumption basket, and its price swings are quickly reflected in the consumer price measurements. With rising inflation central banks face a dilemma: should they assume this kind of price shock cannot be controlled and ignore it; or does monetary policy have a role to play in preventing spillovers to the rest of the economy?
A 2010 IMF working paper from researchers Luis A. V. Catão and Roberto Chang provides interesting insights from the orthodox economic framework. According to them, food price pressures can lead to cycles of broad and persistent inflation, and an ideal response would be a “coordinated action by key central banks” based on a global inflation targeting system. However, they admit such coordination would be quite problematic: the huge differences in income and in the structure of consumption baskets among countries make the problem and the urgency to solve it much more acute in poorer countries — I would add to this that the growth outlook and the commitment of central banks in most developed countries practically rule out any rise in interest rates in the next couple of years, at least.
Discarding a global response, each central bank is left to deal with the problem within its own capabilities. Catão and Chang recommend pursuing a “strict target of broad inflation.” If strictly followed, this recommendation would lead to interest rate shocks in response to food price shocks. In an environment of slow global demand, the social costs of this kind of policy can be very high: higher interest rates can damage growth and employment and increase the hardship among the poorer, while not necessarily bringing down food prices, which are driven by several factors other than demand.
Jeremy Grantham, a respected fund manager and philanthropist, suggests in an article for the Financial Times that “we are in the midst of a global food crisis,” a crisis so severe and consequential that it should not be left to be solved by market forces and “cowboy capitalists” (and, I dare to infer, central bankers). He predicts that the pressure from China and other large food importers will soon force the United States and other developed powers to think of a sort of global solution. The world hasn’t seen such large collaboration since after the Second World War; can we expect wisdom and magnanimity in peace times?