A Decade of Impact of Monetary Policy on Food Inflation: An Overview and Future Direction

Abstract

This article presents a systematic literature review spanning the decade of 2010–2020 in a thematic fashion. It provides an in-depth analysis of how monetary policy regimes are responding to food inflation. It discusses about factors driving food inflation and the manner in which efficiency of financial markets facilitate policy transmission. Further, it explains how food insecurity is exacerbated by rise in food prices and the way high-income countries protect their farmers through input subsidies, indirectly contributing to global food price hike. It also argues that a strong monetary policy credibility can lend stationarity and mean-reversion to inflation rates. Next, it discusses the issues faced by central banks in measurement of inflation such as conflict of choice in different inflation measures and supply side constraints ranging from high farm-to-fork mark-ups to cartelization and hoarding. In subsequent section, it deals with the question whether to target headline or core inflation. After that, it presents a snapshot of various advanced and emerging countries operating their monetary policy in the presence of fiscal policy. It illustrates that the degree of fiscal intervention should be decided according to individual threshold of every country, taking into account the proportion of Ricardian and non-Ricardian population.

Keywords

Monetary Policy Food Inflation Commodity Price Shocks Headline Inflation Core Inflation

Introduction

In the past few years, the world has seen many episodes of global food shocks, particularly in 2007 and 2011 followed by a drop in prices in 2014 (Figure 1) (FAO, 2020). Faced by the challenge of containing the prices, policy makers across the countries face this dilemma: To go or not to go for monetary contraction. Interest rate tightening reduces the output and income and may not leave a significant footprint on food inflation.

Figure 1.

Source: FAO (2020).

Many countries, especially emerging economies, provide for explicit food subsidies to their people due to lower food access. These countries, in contrast to developed economies, typically have lower agricultural capacities (in terms of fertilizer consumption or yield per hectare). Also, they spend 41.5% on food, on an average, out of the total consumption expenditure (Ginn & Pourroy, 2020). Thus, fiscal intervention through budget outlays is a popular method in middle-income and low-income countries, where inflation is assumed to be driven by supply shocks.

Food subsidies come with their own costs. They may not reach the intended beneficiaries and are prone to leakages. Thus, it becomes imperative to examine the efficiency of monetary policy in conjunction with fiscal policy to deal with price surges. Further, analysing the policy response is not sufficient; one needs to understand the underlying factors of how these finalized food prices arrive in the market. This article reviews the domestic hurdles in determination of food prices. It examines the efficiency of agricultural markets in discovering prices. In India, on an average basis, farmers share around 48% of the consumer price for vegetables and 37% for fruits (Bhattacharya et al., 2019). Therefore, it assesses the impact of high mark-ups charged by commission agents, hoarding, lack of credit facilities to farmers and abysmal presence of e-markets for agricultural produce (Madaan & Sharma, 2019). Moving on, the article explores in detail what is an optimal monetary policy. There are two strands of literature which advocate core inflation targeting and headline inflation targeting, respectively. This article highlights the pros and cons of both techniques and make a case for distorted headline inflation targeting, especially for emerging economies (Ginn & Pourroy, 2019). In Next section, a case for coordinated response of fiscal and monetary policy is made.

Despite a vast amount of research in this area, there are very few theoretical reviews as most of the papers have empirical inclination (Paul & Feliciano-Cestero, 2020). Therefore, this article is an attempt to fill that gap by scrutinizing various facets of research done in this area. With that intention, it poses following research questions:

What are the factors influencing food inflation and monetary policy?

What are the challenges faced in the measurement of inflation on domestic and global level?

Which measure of inflation is appropriate to target: Headline inflation or Core inflation?

How should monetary policy react in the presence of fiscal intervention?

The remaining article is organised into following sections: Section 2 presents the methodology and selection criteria of journal articles. Section 3 explains the findings and includes a comprehensive discussion on them. Section 4 puts out a research agenda for future. Section 5 concludes the research.

Methodology

The following article is a structured systematic review of literature spanning the recent decade between 2010–2020. To condense the results, the article takes on a narrative tone along with a thematic framework (Paul & Criado, 2020). Five broad themes have been identified across the articles, which are named as follows:

Stylized facts relating to food inflation and monetary policy

Headline inflation or core inflation: Which way to go?

Issues in measurement of inflation

Coordinated response of monetary and fiscal policy to commodity price shocks

Database Selection

This study has been conducted with the intent of capturing historical information on how policy variables interact with different components of inflation. To ensure adequate quality standards are met, all the papers have been sourced from ScienceDirect database by Elsevier. Further, only ABDC listed journals have been used for this research. Magazines have been excluded from the research criteria, only review articles and research articles have been included to maintain the academic vigour.

Time Period Selection

The time period for this study was selected from 2010 to 2020, since after the financial crisis of 2007–2008, a lot of questions have been raised on the credibility of inflation targeting as a policy measure. Looking in retrospect, the year 1990 marks the beginning of era of inflation targeting in monetary policy. Monetary regimes across the world have had their fair share of experimenting with money-supply targeting during 1980s and exchange rate targeting during 90s. While the former gave in to violent money demand shocks, the latter succumbed to currency crisis of 1990s. When the pegged exchange rates came under crippling speculative attack, the world realized it was time to move on to a new route of policy transmission (Frankel, 2012).

In 1990, New Zealand was the first country to officially announce inflation targeting as its monetary policy stance, and rest of the countries followed the suit in forthcoming years. By including papers from last one decade, the article tries to answer some of the doubts surrounding success of inflation targeting regimes. It critically evaluates what should be an optimal monetary policy and discusses whether policymakers should target headline inflation or core inflation for welfare maximization (Holtemöller & Mallick, 2016).

Articles and Keyword Selection

An extensive search was conducted of the selected journals, in order to identify and analyse the previous published research. Keywords that were used in finding the relevant articles were ‘monetary policy’, ‘commodity prices’, ‘food prices’, ‘food inflation’, ‘inflation targeting’, ‘core inflation’ and ‘headline inflation’. For additional filtering, only peer reviewed articles were chosen. After applying above filters, 150 articles were shortlisted. The abstracts of all 150 articles were thoroughly examined to check the appropriateness for analysis. Finally, 25 articles were selected on the basis of relevance to the study. The selection process has been elaborated through Prisma flow diagram in Figure 2 (Moher et al., 2009).

Figure 2.

Source: Moher et al. (2009).

Many of the excluded articles were related to contribution of commodity price hikes to formulation of monetary policy, which is a vast area of research in itself and demands a separate study. In order to complement the study, certain reports (e.g., World Bank, FAO) and news articles have been selected for enriching the study and strengthening it with contemporaneous data (Erlingsson & Brysiewicz, 2017).

The selected papers are empirical in nature and discuss issues related to an optimal monetary policy to deal with food price shocks, issues in measurement of inflation, pass through effect of global food prices to domestic inflation and coordinated response of fiscal and monetary policy to food price shocks among others (Bhattacharya & Jain, 2020; Catão & Chang, 2015).

Findings and Discussion

Overall, the review finds that choice of monetary policy is a function of level of income of people in various countries, among other influencing factors. High income countries, with developed financial markets, should target for core inflation whereas lower/middle income countries should aim for a distorted headline inflation target (Kara, 2017). Few papers also advocate for moderating interest rates in the presence of fiscal intervention (Durevall et al., 2013). Many countries, especially the developing ones, need to work on methodological flaws in calculation of an inflation indicator. The result analysis begins with observing the year-wise distribution of articles and unfolds into thematic discussion of the consolidated research (Paul & Criado, 2020).

Distribution of Articles Year Wise

The articles were categorized on yearly basis from 2010 to 2020 to identify the publication trends in the academic research of impact of interest rate policy on food prices, as shown in Figure 3. Studies 2010 onwards are considered the initiation point of research on this subject as the year marked the recovery from sub-prime crisis of 2008. Of the 25 selected papers, 12, that is, 48% were published in the year 2015, 2019 and 2020. The most recent papers, published in 2020 draw attention to alternative routes of practising policy, such as nominal GDP targeting and product-price (PP) targeting (Gelos & Ustyugova, 2017). It marks a departure from earlier papers, which talk about synchronized policy response of monetary and fiscal policy or explore flaws in measurement of inflation. It seems, after ten years of 2008 recession, when inflation targeting clearly failed to contain the crisis, the economists across the world have finally started to acknowledge the limitations of inflation targeting.

Figure 3.

Source: The author.

Stylized Facts Relating to Food Inflation and Monetary Policy

Factors Driving Inflation

In order to understand factors contributing to food inflation, one needs to understand that inflation can be an outcome of either demand-pull factors, cost-push factors or inflationary expectations. Demand-pull inflation is a rise in aggregate demand, through four expending sections of the economy: households (C), businesses (I), government (G), and foreign buyers (Net Exports). When aggregate demand rises, increased profitability of production in turn creates an excess demand in the labour market which pulls wage rates up. On the other hand, Cost-push inflation is a fall in the aggregate supply of goods and services arising due to an increase in the cost of factors of production, namely, land, labour, capital and entrepreneurship. Demand driven inflation can be caused by a surge in economic activity, escalated government spending, or overseas growth while a jump in the costs of raw materials or labour, extreme weather conditions such as floods or droughts, oil price volatility and disruptions in bio-fuel market can contribute to cost-pull inflation (García & Mejía, 2018).

Moving on to the third component, inflationary expectations are not found to have a significant impact on current inflation, but zero-bound on interest rates and looming recession due to pandemic of COVID-19 calls for experimenting with non-traditional monetary policy stance such as, moderating inflation expectations (Wong, 2020). Inflation expectations are shaped by shopping experiences (particularly in groceries), access to media information and knowledge about monetary policy (Coibion et al., 2020). Households use this information to plan their purchases in near future while the firms use this information in their hiring, pricing, financing and investment decisions. The non-traditional strand of research calls for altering inflation expectations of agents, through targeted and layered communication strategies, so that perceived real interest rate can be altered without any changes in nominal interest rate.

It is also found that households and firms in developed countries are less aware about interest rate changes than those in developing countries, largely because of stable monetary policy operations in past decades. Emerging or poor countries might have unpleasant experiences with policy changes in terms of high inflation or reduced output, as a result people tend to keep an eye on interest rates. Therefore, one needs to calibrate their communication strategy through post-meeting press briefings, statements by financial experts and open letters according to the awareness levels of agents (Moreira, 2014, 2020). However, since this is a novel approach, it demands extensive research in future to understand the challenges to implementing inflation expectations as a policy tool and propose new communication strategies to improve the responsiveness of expectations to monetary policy.

Efficiency of Financial Institutions and Policy Transmission

Weak financial markets are known to respond poorly to interest rate hike. Even if the central banks raise the interest rate, it might not be transmitted effectively by commercial banks to consumers. Other factors such as excess liquidity in the banking system, weak money demand due to prevalence of barter trade in rural areas exacerbates the problem (Durevall et al., 2013).

To approximate the efficiency of financial markets (The World Bank, 2019) uses the spread between lending rate (the rate at which banks lend to firms) and deposit interest rate (interest rate paid by commercial banks on its demand and time liabilities). The bank lending-deposit spread stands at an average of 7.3% for the world, while it is 4.4.% for high-income countries, 7.0% for upper-middle countries, 7.7% for lower-middle income countries and 11.2% for low-income countries (Table 1). Hence, it is highly likely that the effect of an interest rate surge will trickle down faster in well-oiled financial markets of high-income countries. Similarly, the fact that financial services are not evenly accessible to everyone also plays a major role in determining the impact of interest rate change.

Table 1.

Income-Wise Distribution of Efficiency of Financial Institutions across Countries

Efficiency of Financial Institutions (Bank Lending-Deposit interest rate spread)
	Average (in %)	Number of Economies
World	7.3	122
High-income countries	4.4	29
Upper-middle income countries	7.0	40
Lower-middle income countries	7.7	32
Low-income countries	11.2	21

Source: The World Bank (2019).

As per the estimates in Table 2, on an average, only 58% people in the world enjoy an access to financial institutions, however, there is much disparity among different income-level countries; with high-income countries scoring an 89.6% access while the same looms as low as 25% for low-income countries. This limits the ability of the policy to smoothen any increase in food prices.

Table 2.

Income-Wise Distribution of Access to Financial Institutions across Countries

Access to Financial Institutions
	Average (in %)	Number of Economies
World	58.0	143
High-income countries	89.6	47
Upper-middle income countries	58.0	37
Lower-middle income countries	39.7	34
Low-income countries	25.0	25

Source: Global Financial Development Report, 2019–2020.

Food Scarcity and Rising Food Prices

There are people in the world so hungry that God cannot appear to them except in the form of bread.

—Mahatma Gandhi

Poverty and malnutrition are widespread in low income countries, especially in parts of Asia and Africa (FAO et al., 2020). As indicated in Table 3, the prevalence of under-nourishment for Africa stood at 19.1% in 2019, followed by Asia at 8.3% (2020). In the event of global price rise in food sector, these economies are marred by weak financial markets, towering non-performing assets (NPAs) and high volatility in capital inflows (Akyurek et al., 2011). In contrast, prevalence of undernourishment in Northern America and Europe is less than 2.5%, lending credence to the fact that food security is stronger in countries with high levels of income. These economies are characterized by robust financial markets and elastic lending practices which ensure smooth transmission of monetary contraction to different sectors of economy.

Table 3.

Region-Wise Distribution of Prevalence of Undernourishment in the World (in %)

Prevalence of Undernourishment (PoU) in the World (%)
Regions	2019	2030 (Expected)*
World	8.9	9.8
Africa	19.1	25.7
Asia	8.3	6.6
Latin America and the Caribbean	7.4	9.5
Oceania	5.8	7.0
Northern America and Europe	<2.5	<2.5

Source: FAO et al. (2020).

Note: *The projections up to 2030 do not include the effect of COVID-19 pandemic.

Another study on rural Ethiopia focuses on association between productivity growth and poverty, rather than focussing on relationship between assets and poverty. It finds that improvement in agricultural productivity can have significant impact on poverty reduction through improving technical efficiency. The government should strive to make available inputs in rural Ethiopia, enhancing access to nearest markets and towns, reducing inflationary pressures and following a prudent population policy (Abro et al., 2014).

Another reason which might drive the food prices up is speculation in commodity markets. Some researchers consider speculation in commodity prices as an almost criminal act, since greed of a few is bringing about deaths from hunger in poorer sections of the world. The dismal situation of food insecure countries is exhibited in terms of widespread presence of undernourishment, wasting and stunting in children, anaemia amongst women of reproductive age (15–49 years) and limited breastfeeding amongst newborns (0–5 months of age) (FAO et al., 2020). However, there is a lack of compelling evidence against speculation contributing to the rise in food prices. Index based trading in agricultural futures markets is frequently blamed by the policymakers for price hikes but studies rarely point out any causal relationship between the two, including commodities which are sensitive from the point of view of food security as well as the industrial use commodities (Capelle-Blancard & Coulibaly, 2011).

Interestingly, a research conducted in Pakistan advocates that government should emphasize on investing in social and physical infrastructure instead of doing transfer payments in agriculture sector due to its crowding out effect. Therefore, there should a strong impetus for developing agricultural markets and transport channels rather than offering agricultural subsidies (Akbar & Jamil, 2012).

Trade Openness and Food Prices

International trade in agriculture is often marred by numerous tariff and non-tariff barriers on imports, taxes and restrictions on exports. In 2015, WTO called for eliminating agricultural export subsidies to create a fair-trading environment, especially for farmers in poor countries. Despite the agreement, many countries continue to place such restrictions to stabilize domestic prices and protect themselves from global price shocks. However, there is no evidence of such restrictions being effective in containing domestic prices.

In fact, a rise in food prices may set in motion a series of tariff barriers that further aggravates the global price hike in food sector that, in turn, contribute to even more confining policies. As one can observe in Table 4, nominal protection rate for agricultural production is 10.9 for high-income countries, 2.6 for middle-income countries8 and –37.7 for low-income countries. This implies that high and middle-income economies have been protecting their farmers through input subsidies, sanitary and Phyto-sanitary measures and import quotas which reduces overall global welfare (FAO et al., 2020).

Table 4.

Income-wise Distribution of Average Weighted Nominal Rate of Protection Across Countries

Average Weighted Nominal Rate of Protection (Agricultural Production in Low-Income Countries Is Penalized, While in Middle and High-Income Countries it Is Supported (2005–2016))
High-income countries	10.9
Middle-income countries	2.6
Low-income countries	–37.7

Source: FAO et al. (2020).

Notes: Nominal rate of protection defined as the ratio of the price difference (gap between observed and reference prices at farm gate) and the reference prices at farm gate. Time period for calculating average is from 2005–2016.

Monetary Policy Credibility and Food Inflation

Valera et al. (2017) offers a threefold definition of inflation targeting based on credibility: perfect, weak and zero credibility. A perfect credibility is defined as where stationarity of inflation is established across all quantiles. In economies with weak credibility, there are chances of mild non-stationarity in certain quantiles. The authors come up with novel evidence for globally stationary inflation rates for all inflation-targeting and non-inflation targeting Asian economies of the sample 8 countries except for Hongkong.

The negative approximations of deterministic time trend are majorly significant for IT countries and are lower than non-inflation targeting countries. This means inflation targeting countries have been forging their credibility and if trends are stationary, it will help policymakers to assume mean reversion conclusively after controlling for structural breaks. This piece of information can aid them in forecasting future movements in inflation with higher accuracy.

Headline Inflation or Core Inflation: Which Way to Go?

Policymakers generally face the dilemma of how to react to a food price shock, that is, what exactly to target: Headline (the overall inflation in the economy) or core inflation (obtained after removing the transitory components of food and fuel prices from overall inflation). The reaction to interest rate shock differs in non-food (core) sector, where prices tend to be sticky as compared to farm (headline) sector where prices are flexible. Literature suggests focussing on core inflation for social welfare maximization under efficient market hypothesis (Bhattacharya & Jain, 2020). When the financial markets are inefficient and food comprises a substantial portion of CPI basket, policymakers should target headline inflation. Hammoudeh et al. (2015), for instance, evaluate a small open economy DSGE model for Chile through the application of an alternative Taylor rule. The empirical result illustrates that food inflation plays an essential role in shaping Chile’s de facto monetary policy response. Keeping in tandem with its commitment towards price stability, the central bank raises the policy rate to counter food inflation. Despite an immediate monetary policy response, the policy rate is attenuated by second-round effects of non-food inflation propagated by the food price shock. Overall, in order to maximise welfare, they recommend targeting headline inflation for Chile.

A major strand of literature questions the idea of following a pure inflation target and instead suggests using a distorted headline inflation target. Few studies also build a weighted price index, assigning appropriate weights to food, fuel and non-food goods as per their contribution to GDP. Kara (2017), for instance, builds a New Keynesian economic model that divides the economy into two sectors namely, sticky prices sector and flexible prices sector (which, through prior researches, is assumed to be food and energy dominated). The model incorporates a pricing rule determined by various factors such as marginal cost, wages, cost of capital, factor productivity, inflation, price level, elasticity of demand and presence of fixed costs, among others. The central bank is presumed to follow a generalized Taylor rule where short-term interest rate adjusts to changes in inflation, output gap and growth rate of output gap. To analyse the fit of Taylor rule, the authors build two different measures of inflation. The first measure takes into account pure headline inflation while the second considers a weighted inflation index comprising of 90% non-food prices and 10% food and energy prices. It is found that Taylor rule fits better to the weighted inflation index than headline inflation index.

One needs to understand that there are more than few factors at play during the transmission of policy rate to consumption and investment. For instance, if we are assuming an open economy, it naturally follows that the economy will have tradable and non-tradable variety of commodities in both food and non-food sector. Tradable variety refers to goods which are different from domestically consumed non-tradable goods in terms of quality or cultural distinction (Pourroy et al., 2016).

Similarly, one also needs to question whether few agents in developing countries have better access to financial information than others. Under an open economy, agents dealing in tradable variety of goods often have access to international pricing information. Anand et al. (2015), in that case, construct an optimal price index placing substantial weights on food prices, but unlike headline inflation, assign zero weight to imported goods; the reason being agents in this sector are exposed to financial markets and face a flexible price elasticity of demand. In conclusion, they make a case for targeting this price index for developing economies, where households are credit constrained and food comprises a big share of total consumption.

There has been a growing concern that central banks should recognize the sector from which inflation emanates before implementing contractionary monetary policy. Using a Structural VAR (SVAR) model, Hammoudeh et al. (2015) study how U.S. monetary policy affects sectoral commodity prices (including the prices of food, beverages, agricultural raw material, metals and energy commodities) and macroeconomic activity. The empirical evidence, however, indicates that a U.S. monetary contraction causes a spike in the broad commodity price index, which shows that other factors might be at play, such as an aggregation bias, higher inflationary expectations, excessive speculation or high production costs. Then, the response tapers off after six quarters as the positive interest rate shock disappears and higher interest rates drain the system of its liquidity. Despite this, the aggregate price response masks the presence of noteworthy variation in the price responses of individual sectoral prices. In conclusion, policy makers should identify the source of sectoral inflation before implementing a contraction in interest rate. After taking into account above suggestion, the design of core inflation targeting is found to be more welfare maximising than headline inflation.

A monetary policy can impact the prices through various channels such as interest rate hike, exchange rate appreciation, bank credit route and asset price channel. Under exchange rate transmission, world food inflation causes the tradable food to become costlier, so that people start substituting it with non-tradable food. Gradually, non-tradable food prices also start rising due to demand pressure leading to a slow rise in domestic inflation. On the other hand, tradable non-food goods are now cheaper, so people start substituting the non-tradable non-food goods with the tradable ones. Overall, the rise in tradable food exports predominates fall in tradable non-food exports leaving the country with a positive trade balance and spreads domestic inflation over a long period. The optimal monetary policy in such cases will be to target sticky prices (Pourroy et al., 2016). For low income and middle-income countries, prices tend to be sticky for non-tradable goods. Also, these prices form a large part of the total basket and cannot be ignored. Therefore, the optimal policy for low and middle-income countries would be to target headline inflation. For high income countries, however, the central bank can afford to neglect the non-tradable food prices, as they constitute a small portion of the total basket and majority of food consumption is of tradable quality.

Monetary policy tightening works from both sides, namely production cost channel, that is, supply side and aggregate demand (AD) channel. For the former, an interest hike makes capital investment costlier, making producers shift to labour even in capital intensive sectors. This leads to rise in labour prices in food sector, further raising the prices. Ultimately, it leads to a spike in headline inflation. In the latter case, an interest rate hike causes a downfall in consumption, investment and GDP growth rate bringing down the prices and food inflation. Bhatt and Kishor (2015) and Bhattacharya and Jain (2020) empirically examine the effect of monetary policy through demand channel in the presence of supply side channel on food inflation in a panel of advanced and emerging economies. In developed economies, cost channel dominates with positive rise in all prices (price puzzle), whereas for emerging economies, AD channel dominates for core inflation with negative effect, but because of Engel’s law, it has a weak effect on food and headline inflation.

Moving on, a study by Gelos and Ustyugova (2017) present some interesting facts related to performance of inflation targeting during sub-prime crisis. The article studies the trans-border performance of core and non-core inflation around 2008 asset price shock and finds out that these shocks have more intense effect on emerging economies than the developed ones. Countries with less autonomy, lower credibility of central bank and poor governance are significantly experiencing larger pass-throughs of food price shocks from world to domestic inflation. During 2008 price shock, a tighter monetary policy helped contain the inflationary impact but the authors do not find any significant difference between performance of inflation targeting regimes and non-inflation targeting regimes during 2008 recession.

Issues in Measurement of Inflation

Relevance of Different Inflation Measures

There are multiple indicators of inflation such as consumer price index (CPI), wholesale price index (WPI), private final consumption expenditure (PFCE) deflator and gross domestic product (GDP) deflator. A central bank faces the challenge of determining the best measure of inflation as per the economic conditions of their country. CPI is considered to be a better estimate of retail inflation than WPI. CPI and PFCE are good for measuring consumer inflation as PFCE doesn’t include capital purchases such as machinery. These measures also show higher inflation due to heavy weights assigned to food items and services than WPI. PFCE has an edge over CPI but it is an implicit deflator. Implicit deflators derived from actual GDP whose composition is changing, are not a measure of price change as they do not correspond to a fixed bundle of goods. Moreover, deflator-based inflation measures reflect value heavy transactions of rich households while CPI shows the rise in food prices for poor. In Moorthy and Kolhar (2011), when food prices rise to 1.10 and real GDP also goes up, implicit deflator falls steeply relative to CPI, because it is transactions weighted and takes into account voluminous transactions of rich. Finally, to deal with food price shock through monetary policy, the authors argue for a population weighted CPI assigning weights to rich and poor households.

High Farm-to-Fork Mark-Ups, Cartelization and Hoarding

Imperfect agricultural markets are a perfect breeding place for intermediaries who exploit the farmers and the consumers alike. Farm-to-fork mark-ups at the wholesale level comprise not only marketing and transportation costs, but big profit margins for wholesalers. Growth in mark-ups fuels the wholesale as well as the retail prices. According to Bhattacharya et al. (2019), if supply chain reforms had been undertaken and mark-up to retail and wholesale prices had not grown for a period of 2009–2016 in India, the realised inflation rate would have been 3% and 4% lower for retail and wholesale annualized inflation respectively.

The key here is to de-regularize the agricultural markets and allow entry of private players as buyers of crops. Secondly, the governments should aim to unify regional markets through electronic mode so that farmers can bargain a better price across national platforms. However, a word of caution, law cannot be practised in isolation. Hence, an efficient implementation is essential to ensure these changes are beneficial not only to agricultural productivity, but also for farmers, especially the ones without ownership of landholdings (Frankel, 2012; Singh, 2019; Yadav, 2020).

Madaan and Sharma (2019) further build a price forecasting model (30 day in future) after employing seven different models for mandi price forecasting to empower smallholder farmers and low-income consumers in India. The article argues that commission agents should be abolished. Instead, paid services to assess the quality of produce should be brought in. Secondly, cross-mandi trading should be allowed. Thirdly, formal credit and electronic marketplaces should be encouraged.

Alternative Measurement of Core Inflation

Bhatt and Kishor (2015) finds that both food and energy prices have significant permanent components, whereas manufacturing exhibits transitory components. It also registers a strong feedback effect between food and manufacturing prices. It advocates for a long run trend inflation measure which includes permanent portions of manufacturing, food and energy prices. This will help in obtaining a better estimate of future inflation and superior conduct of monetary policy (inflation targeting through Taylor rule).

Trend-Reversion in Inflation

A lot of studies have been conducted on mean reversion in inflation but very few studies estimate the trend-reversion in inflation. If there is a stationary trend that inflation tends to return to, it will be easier to forecast future movements of price surge. Valera et al. (2017) finds that the negative estimates of deterministic time trend are mostly significant for inflation targeting countries and are lower than non-inflation targeting countries. This means inflation targeting regimes have been building their credibility and if trends are stationary, it will help policymakers to assume mean reversion conclusively after controlling for structural breaks. It can further help them in forecasting future movements in inflation.

Coordinated Response of Monetary and Fiscal Policy to Commodity Price Shocks

An optimal monetary policy is best defined with respect to population set. With Ricardian population, that is, those who have access to financial markets and are employed in manufacturing sector, one must target core inflation combined with low fiscal intervention. In Non-Ricardian population, that is, those who work in farm sector and do not have access to financial markets, one must target headline inflation alongside high to moderate fiscal intervention (Ginn & Pourroy, 2019). To design a resilient monetary policy, a central bank should numerically identify the degree of fiscal interference according to the fundamentals of their own country. Once the proportion of monetary action is decided, the article proposes to also look at sectoral inflation, in which case, core inflation targeting turns out to be the optimal choice in the context of implementable Taylor rules. In fact, in many countries with fiscal subsidies and sticky prices, targeting the headline inflation fetches more welfare losses than targeting the sectoral inflation. However, one must note that even sector-wise targets are not one-stop solutions. A diverse group of countries may assign varying degrees of importance to the same sector, which will result in differing amount of sectoral subsidies and consequently more than one optimal monetary policy (Ben et al., 2012).

Apart from aiming at sectoral inflation, policy makers can also opt for distorted headline inflation, that is, the difference between the market price and subsidized price, in order to achieve the highest welfare. It leads to an interest rate response below headline inflation target, but higher than core inflation (2019).

The case of Turkey is another interesting example of how inflation targeting (IT) can find success in the presence of fiscal intervention. Before adopting inflation targeting, Turkey had 68% inflation, a public debt to GDP ratio of 90% and weak banking system. Secondly, Turkish economy was highly dollarized and adopting IT could aid it in becoming part of European Monetary Union. Kumar and Dash (2020) finds that both output and inflation became less volatile after introduction of inflation rate targeting. There have been few fluctuations due to real exchange rate movements in 2006 and during subprime crisis, but on the whole, the article advocates good financial discipline coupled with inflation targeting as the panacea for inflation. Similarly, in Iddrisu and Alagidede (2020), a hike in monetary policy stance destabilizes food inflation, presenting challenging welfare dynamics since South Africa is already burdened with high poverty and income inequality. The economy can either continue with restrictive monetary policy so that negative effects from demand side outshine the positive effects of production cost channel and the prices are stabilized, or it can complement its monetary policy with fiscal policy in the form of price subsidy to smoothen the interest rate transmission. Here, the former alternative leads to reduction in food and non-food output, a costly proposition for a poor country like South Africa, thereby making a case for the latter option (Iddrisu & Alagidede, 2020).

Another branch of literature emphasizes real interest rate is a sum of Wicksellian natural real rate and risk premium. The risk premium in the equation is a function of fiscal discipline. Kumar and Dash (2020) contends that as fiscal credibility improves, risk premium decreases causing the actual inflation to fall without bringing any change to the monetary policy rate. If the government implements monetary contraction in conjunction with fiscal measures, it might lead to excessive tightening in the economy and the policy stance becomes counter-inflationary. In the case of India, a contractionary monetary policy works in favour of reducing overall and sectoral inflation although one can observe the effect was lessened from 2010–2014 due to external supply shocks of oil price hike and 2009 draught.

Also, in some emerging economies, monetary policy does not affect food inflation, and instead, the exogenous supply shocks such as minimum support prices (MSP) and monsoon do. As Akyurek et al. (2011) puts it, a hike in interest rate affects manufacturing sector more than agriculture sector as some individual commodities respond positively to inflation, that is, show signs of price puzzle. In Ethiopia, inflation is largely determined by food prices which continued to soar during 2005–2009 despite favourable crop production and good weather. Durevall et al. (2013) postulates that despite a small share of imported food prices in international trade, long run evolution of food prices in Ethiopia is determined by external sector, again an external supply shock. Reasons include intervention by government and donors in terms of export and import of food grains in response to variations in harvests. This might have limited the impact of local food supply shocks. Secondly, the large size of wholesale market for grains at Addis Ababa makes it a de-facto price transmitter for local markets. The wholesale dealers are well informed about world prices, duly passing them into local markets. Thirdly, the monetary policy is ineffective due to excess liquidity in the banking system, weak money demand due to prevalence of barter trade in rural areas.

In another interesting policy stance, García and Mejía (2018) proposes a macroeconomic policy stabilizing inflation from commodity price shocks, while acknowledging the fact that these economies are not only affected by these booms and bust, but are also favoured by them. The article analyses the two cases: in first, it implements an aggressive monetary policy and an acyclical fiscal policy, where the only goal of central bank is to stabilize inflation. It works effectively but also reduces aggregate demand. As a result, production falls down resulting in fall in labour demand and lower real wages. The above chain of events acts as a supply shock to the economy. In second case, the policy not only aims to reduce inflation, but also to stabilize restricted (non-Ricardian) household consumption through fiscal transfers. Due to a counter-cyclical fiscal policy in combination with monetary tightening, the drop in consumption of restricted households is much lower than before. However, it is detrimental to the welfare of Ricardian households who earn less profits now. Many economies can take advantage of the boom periods and save their fiscal revenues from exports (García & Mejía, 2018; Moreira, 2014). These funds can be used to offer price subsidies to maximise the welfare of non-Ricardian households. Of course, in the event of a global price fall, these subsidies can be reduced or eliminated to encourage savings for a rough time in near future.

Lastly, in the aftermath of sub-prime crisis, economists started questioning the resilience of inflation targeting. Valera et al. (2017), in response to fluctuations in global food prices, formulates an open economy model in which imported food has larger weight in consumption than abroad and international risk sharing can be imperfect. The article allows for real exchange rate and terms of trade to move in opposite directions in response to food price shock. It postulates that monetary policy can work through either stabilizing output prices or exchange rate route, depending on international risk sharing and price elasticity of exports. If international risk sharing is perfect, then consumer price index (CPI) targeting and expected CPI targeting can outperform production price index (PPI) targeting. However, even a mild deviation in risk sharing can make PPI targeting more favourable. This proof paves way for alternative forms of controlling inflation such as nominal GDP targeting and product price targeting.

Future Research Agenda

The literature on monetary policy action for food inflation is quite sizeable, although diverse in nature (Paul & Feliciano-Cestero, 2020). The present article has synthesized various offshoots of the research into a broad framework, although it could have included more research databases and extended the period under study. For research in forthcoming time, researchers can use following points to advance study in the area of policy responses to inflation:

To study what drives global food prices in order to reduce exposure to commodity price shocks in future.

Commodity-specific research on portions of aggregate food index such as dairy, sugar, and so on, to examine the formation of inflation expectations and their role in shaping overall inflation.

To link inflation expectations with economic decisions of households and firms empirically

To develop high quality surveys for measuring the inflationary expectations of households and firms

To examine the role of speculation in commodity markets on food insecurity.

To explore the scope of Nominal GDP targeting and Product Price targeting as policy measures.

Conclusion

Overall, the present research provides an in-depth analysis of how monetary policy regimes are grappling with food inflation. The study begins with exploring certain relationships between factors influencing both food inflation and monetary policy. It discusses about factors driving food inflation and how efficiency of financial markets facilitate policy transmission. Further, it talks about how food insecurity is exacerbated by rise in food prices and how high-income countries protect their farmers through input subsidies, indirectly contributing to global food price hike. It also explains how a strong monetary policy credibility can lend stationarity and mean-reversion to inflation rates.

Moving on, the article explains the issues faced by central banks in measurement of inflation such as conflict of choice in different inflation measures and supply side constraints, for instance, high farm-to-fork mark-ups, Cartelization and Hoarding. It also highlights the ideas of alternative measurement of core inflation and trendreversion in inflation, as proposed by few researchers.

In subsequent section, it deals with the question whether to target headline or core inflation. After that, it presents a summary of how different countries are operating their monetary policy in the presence of fiscal policy. The degree of fiscal intervention should be decided according to individual threshold of every country, taking into account the proportion of Ricardian and Non-Ricardian population. Finally, the article is concluded by providing alternatives to inflation targeting in terms of nominal GDP targeting and product price targeting.

Footnotes

Declaration of Conflicting Interests

The author declared no potential conflicts of interest with respect to the research, authorship and/or publication of this article.

Funding

The author received no financial support for the research, authorship and/or publication of this article.

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