Rising Commodity Prices Won't Cause Inflation

Woman bagging groceries
Katrina Wittkamp | The Image Bank | Getty Images
Woman bagging groceries

The surge in commodity prices has many worried about skyrocketing food prices at home. But a look at how much the increase in raw commodities actually makes it to the plate, at least in the United States, shows that it is unlikely by itself to cause widespread inflation.

It’s not that inflation is not a significant worry. It’s that commodity prices are not enough to make it happen.

To be sure, prices that people pay at the grocery store will go up. A loaf of bread will become more expensive, as will an ear of corn and a pound of beef, which comes from cattle that are fed corn. But it’s a long way from a spike in the price of a bushel of wheat to a national inflation problem.

Research done at the US Department of Agricultureand MIT shows that, on average, about 19 cents of every dollar spent on food pays for commodities. The remaining 81 cents goes to such things as labor, taxes, profit and energy and transportation. There’s a healthy amount of packaging and marketing taken out of the dollar, too.

That practically limits the impact to about one-fifth of the rise in any commodity showing up in the consumer price index (19 cents on the dollar). But, in fact, it’s smaller that that.

Food represents just about 14 percent of the CPI basket. Another way of thinking about this is that if food prices overall went up by $1, only about 14 cents of it would be reflected in the CPI (Consumer Price Index).This percentage has been coming down quite substantially over the years, reflecting the overall the declining percentage of spending that go to sustaining ourselves with food.

And, in fact, the impact is thought to be smaller still. Food at home, that is, what we make for ourselves, represents just about 8 percent of the basket. The remaining 6 percent is the somewhat discretionary “food away from home” category.

Through December, the Bureau of Labor Statistics reports that food prices are up 1.5 percent overall compared with a year ago. How can that be, when wheat prices are up 61 percent in a year?

The reason is that it’s a very long way from a bushel of wheat to a loaf of bread. Work by the USDA finds that only about 30 percent of the hike in the price of wheat ends up in flour, and just 10 percent ends up in bread.

So take three $10 quantities of wheat, flour and bread. A $1 rise in the price of wheat should over time cause a 30 cent rise in the cost of flour and a 10 cent rise in the cost of bread.

Studies show the price increase is not immediate either. It can take from two to six months for a commodity price increase to filter through to consumer prices, suggesting there may yet be some upward pressure on the CPI in coming months from the rise in commodity prices.

The important takeaway from all this is that it takes more than just a rise in commodity prices to create inflation. It helps a lot (if inflation is what you’re looking for) if wages and other service costs rise. And it helps more to have a broad-based inflation psychology, where people buy now because they are afraid prices will be much higher tomorrow. So far there is little evidence of either in the US.

Note, however, that this is not true in many developing nations, where the consumer price baskets correctly have higher weightings for food, reflecting larger chunks of people's income devoted to nutrition, than in the US.