Price Index, Inflation and Commodity Prices
In early February, the IMF released a worrying report about rising prices of commodities, in particular, it reported rising prices of agricultural products (http://www.imf.org/external/np/res/commod/Table2-020911.pdf). It shows that food price index over 2010 has risen by over 31 percent. In the same period, prices of wheat and corn have increased by 60 percent. The price of cotton has risen over a whopping 130 percent during the same period. What is the reason for such price rises? It has been traced to falling supply due to bad weather anywhere from Australia to Zanzibar.
Average Mexican household spends over 30 percent of its budget on food. Thus, a rising food price naturally worries the Mexican Government. In many countries, rising food price cause riots and topples governments. We have to look no further than the recent events in Egypt. The genesis of the unrest in Egypt can be traced directly to rising price of bread. A few years ago, a substantial rise in the price of onions brought down a democratically elected government in India. In Mexico itself, the Calderon Government has painful memories of 2007. In early 2007, corn price went soaring across the globe. It led to big marches in Mexico City for rising tortilla price.
Since 2006, through SAGARPA (under the APOYOS Y SERVICIOS A LA COMERCIALIZACIÓN AGROPECUARIA or ASERCA), Mexican Government had a program to buy corn futures to guard against agricultural product price fluctuations. The program made sense because Mexican Government routinely provides 50 to 100 percent subsidy to corn consumed in the country. However, such a hedge was not enough in 2007. The price of tortilla rose. To avoid such problems, the budget for ASERCA was raised to over 10 billion pesos in 2010. By the end of 2010, not only did ASERCA buy a large number of contracts of corn futures for 2011 in the Chicago markets, it took the unusual step of giving publicity to such a purchase. Normally, the Hacienda is shy of publicizing such purchases. This would have worked fine except that the recent freak freeze in Sinaloa has led to an almost wipeout of the white corn crop in that state. Sinaloa produces nearly a fifth of Mexico’s white corn – the stuff that humans consume. Thus, the recent loss of crops in Sinaloa, valued at 40 billion pesos has definitely put pressure on agricultural products.
What is the relationship between the prices of agricultural goods and inflation? For a middle income country like Mexico, since a third of the income is spent on food, a substantial rise in price of ingredients of food items feed into inflation. However, a one percent rise in food price does not lead a one percent rise in inflation. Curiously, the INEGI reported in early February that for the month of January of 2011, Mexico experienced one of the lowest inflation rates in months. The president of Banxico, Augustine Carstens went on record declaring that Mexico is on target of 3 plus or minus one percent inflation rate for 2011. Unfortunately, many Mexicans are suspicious of such numbers. Specifically, they do not necessarily believe that the inflation in Mexico is really so low. In Latin America, the governments are known to underestimate the rates of inflation. The additional problem of reporting lag of inflation has been a problem for both the developed and the developing countries.
In the past, underestimated rates of inflation had never been challenged. After all, it is difficult to replicate the survey machinery used by governments to calculate price index. Recent research has begun to change this process. Roberto Rigobon and Alberto Cavallo at MIT’s Sloan School of Management have launched the “Billion Prices Project” (http://bpp.mit.edu). The aim of the website is to publish daily price indexes and provide real-time inflation estimates around the world.
Alberto Cavallo’s PhD thesis has developed a methodology to systematically collect prices of items sold by online retailers and compute inflation statistics on a daily basis. At present, 5 million prices are monitored every day from categories such as food and beverages, household products, electronics, apparel, and real estate. The eventual aim is to track a billion prices. The project tracks prices in more than 50 countries. It currently publishes data for the U.S. and U.K. Italy, France, Turkey and Australia among the OECD countries. It also tracks Argentina, Brazil, Chile, Colombia, and Venezuela in the Latin American region. Cavallo’s research has unearthed one particularly striking case of consistent underreporting of consumer prices by the government of Argentina in the past three years. The inflation rate reported by the government is consistently half of what Cavallo estimated. In his research, he showed that no such tendency was observed in Brazil, Chile or Colombia. Soon, Mexico will join the list of target countries in this project.
Appendix
In the international markets, the term “commodity” is used for some specific goods. In fact, there is a set of specific goods to create a “commodity price index.” This set can be broadly grouped into the following categories: Oil and Gas (energy), Gold and Silver (precious metals), Aluminum, Copper and Zinc (base metals), Wheat, Corn, Soybean (agricultural products) and Cattle and Hogs (livestock).
