Monetary Policy and Food Inflation in Emerging and Developing Economies

Abdul-Aziz Iddrisu, Imhotep Paul Alagidede

• Publisher: Routledge
• Year: 2021
• ISBN:
  9781000528510
• Edition: 1
• Topic: Volkswirtschaftslehre
• Subtopic: Entwicklungsökonomie

This book focuses on the impact of monetary policy and food price volatility and inflation in emerging and developing economies.

The tendency for food price volatility to blot inflation forecasting accuracy, engender tail dynamics in the overall inflation trajectory and derail economic welfare is well known in the literature. The ability of monetary policy to exact stability in food prices, theoretically, has also been well espoused. The empirical evidence, however, is not only in short supply, but also the studies available have dwelt on approaches that underplay the volatile behaviour of food prices. This book focuses on inflation targeting in emerging economies such as Chile, Mexico, Turkey, Brazil, Hungary, Russia, Colombia, South Africa, Indonesia and Ghana, as these are economies with considerable proportion of the consumption basket occupied by food. The book provides the means to understand at first hand the correct way to model food inflation, account for the related policy responses to deviations either in the short or medium to long term, and in market conditions that are subject to excessive variability. Strong evidence is presented that captures deviations of food prices from their trend and the accompanying monetary policy effect in stabilizing such variabilities across distinct frequencies. The novel approach in this book addresses the burgeoning puzzles of asymmetry in monetary policy effect on food prices at high, medium and low episodes of food inflation. In doing so, this book presents a powerful tool for researchers interested in understanding not just the transmission mechanism, but also the magnitudes involved, and to policymakers whose existing tools have failed them. Future studies will do well to deepen the evidence and seek new grounds to which the phenomenon manifests beyond and below emerging markets.

This book will be of great interest to students, scholars and policymakers involved in agricultural economics, financial economics, food security and sustainable development.

1 Introduction and background to the study

DOI: 10.4324/9781003195368-1

Introduction

The dominant role of food prices in driving overall price levels (Iddrisu & Alagidede, 2020; Ginn & Pourroy, 2020); their volatility and persistence that dent inflation forecasting accuracy (Ginn & Pourroy, 2020; Alper et al., 2016; Portillo et al., 2016) and the associated uncertainty in the conduct of monetary policy (Ginn & Pourroy, 2020) are well known in the theoretical and empirical literature. These characteristics are even more pronounced in emerging and developing economies in view of the dominance of food in the consumption baskets of these economies, thereby making optimal conduct of inflation targeting framework a major challenge (see Iddrisu & Alagidede, 2020). Unsurprisingly, many emerging inflation targeting economies have struggled to achieve publicly announced inflation targets over the years and this can affect the credibility of policymakers.

Whether monetary policy exacts stability in food prices, as espoused by the theoretical literature (Ginn & Pourroy, 2020; Pourroy et al., 2016; Catao & Chang, 2015), is an important empirical question that has received little attention in the literature. So far, studies on this subject have focused largely on monetary policy and overall inflation to the neglect of food price stability. Much as some attempts have been made recently in the literature (Iddrisu & Alagidede, 2021; Iddrisu & Alagidede, 2020; Bhattacharya & Jain, 2020; Hammoudeh et al., 2015), fundamental limitations still linger. What makes food prices a major concern for monetary policy authorities is its underlying variability that minimises the accuracy of inflation forecasts; breeds uncertainty in the conduct of monetary policy; destabilise planning and income of farmers/producers and derail economic welfare for the poor in particular. Surprisingly, existing studies, save Iddrisu & Alagidede (2021, 2020), have tended to use models that completely ignore this all-important characteristic of food prices. Although Iddrisu & Alagidede (2021, 2020) employed the quantile regression analysis that captures tail dynamics resulting from outliers in food prices, such an approach fails to address the frequency of food price changes and deviations from the trend that are even more ruinous to inflation forecasting accuracy and engenders uncertainties in the conduct of monetary policy.

Importantly, all the existing studies have been situated exclusively in time domain, ignoring the fact that economic agents have distinct objectives over distinct horizons and frequencies. This obvious mishap was highlighted by Aguiar-Conraria et al. (2008), who posit that the actions of different economic agents are informed by different objectives across distinct horizons which eventually underlie numerous economic processes. The resulting macroeconomic data that are observed are essentially a crystallisation of these distinct economic agents’ objectives and horizons. To examine monetary policy effect on food prices in an exclusive time domain is to obscure the underlying distinct objectives and horizons of economic agents. Indeed, Aguiar-Conraria et al. (2018) argued that monetary policy affects over distinct horizons and especially cyclical frequencies are crucial for policymakers, given the distinct impact on social welfare over these different frequencies.

This book overcomes these limitations in the literature by adopting an approach that situates the monetary policy–food inflation nexus in time and frequency domains. It employs the wavelet-based quantile regressions to capture deviations of food prices from their trend and the accompanying monetary policy effect in stabilising such variabilities across distinct frequencies over time. The application of the quantile regression then gives the added advantage of capturing monetary policy effect on food prices at high, medium and low episodes of food inflation. This further illuminates the well-acknowledged asymmetry in monetary policy behaviour as discussed by Iddrisu & Alagidede (2021, 2020).

The focus of this book is on emerging and developing economies that have large proportions of food in their consumption baskets and high levels of indigence in their economies. Pourroy et al. (2016) reckon that 50% of the budget of households in developing countries is allocated to food alone. Specifically, the focus on inflation targeting economies such as Chile, Mexico, Turkey, Brazil, Hungary, Russia, Colombia, South Africa, Indonesia and Ghana brings into sharp focus, the several dynamics of inflation targeting such as the central role played by volatile food prices that distorts forecasting accuracy of inflation and highlights the essential toolkits of inflation targeting for inclusion in the tool boxes of central banks. The uncertainties that come with such variabilities present enormous concerns for monetary policymakers in exacting optimal policy. As a result, central banks that target inflation place significant importance on food price developments.

The findings show that the effect of monetary policy on food prices for the selected countries is mixed. While monetary policy exerts a positive impact on food prices over different horizons and distinct quantiles in Brazil, Chile, Ghana, Hungary, Mexico, Russia, South Africa and Turkey, its effect on food prices in Colombia and Indonesia is inconclusive. The results in these two countries differ across scales and quantiles. In Colombia, monetary policy delivers stability on food prices only over the short horizon of two to four months. At longer horizons, the effect of monetary policy on food prices in Colombia is positive. For Indonesia, food price stability is exacted by monetary policy over the short to medium horizon. At the longer horizon, monetary policy restriction engenders destabilization in food prices.

Overview of the book

This book takes a careful look at the concept of inflation targeting and its preconditions. It looks at the experiences of the aforementioned emerging and developing economies since their respective adoption of the inflation targeting framework. The book considers the inflation performance of these countries prior and post inflation targeting. The inflation targets that are publicly announced in these countries and how the respective central banks have achieved these targets are examined from a fresh perspective, while the developments in world food prices and the dynamics and trajectories of food inflation in the selected countries vis-à-vis the overall inflation are brought into sharp focus. The co-movements of food and overall prices, the volatilities and persistence, as well as the implications of the underlying volatilities and persistence of food inflation for the conduct of monetary policy in emerging and developing economies are given a new space for broader discussion. Finally, the book delves into the more empirical matters of the monetary policy effect on food prices using wavelet-based quantile regressions and proffer a variety of options for policy.

Structure of the book

This book is organised into five chapters as follows:

• Chapter 1 provides a brief overview and structure of the book.
• Chapter 2 looks at inflation performance, milestones and challenges under the inflation targeting framework in the selected countries. It then compares these outcomes to the performance of inflation prior to the adoption of the targeting framework in each of these countries. In doing so, the chapter also compares actual inflation outturn to the publicly announced inflation targets in these countries.
• Chapter 3 examines the developments in world food prices and the movements in food and overall inflation in the selected countries. It examines the volatilities and persistence in food inflation and the implication for inflation forecasting and conduct of monetary policy in the selected countries.
• Chapter 4 estimates monetary policy effect on food prices in time and frequency domains using the wavelet-based quantile regression approach. This chapter undertakes robustness cheques and discusses the policy ramifications of the results.
• Chapter 5 presents the summary of the journey and explores areas where future research on the topic could yield the greatest reward.

References

• Aguiar-Conraria, L., Azevedo, N., & Soares, M. J. (2008). Using wavelets to decompose the time–frequency effects of monetary policy. Physica A: Statistical Mechanics and its Applications, 387(12), 2863–2878.
• Aguiar-Conraria, L., Martins, M. M., & Soares, M. J. (2018). Estimating the Taylor rule in the time-frequency domain. Journal of Macroeconomics, 57, 122–137.
• Alper, C. E., Hobdari, N., & Uppal, A. (2016). Food inflation in Sub-Saharan Africa: Causes and Policy Implications. IMF Working Paper. WP/16/247.
• Bhattacharya, R., & Jain, R. (2020). Can monetary policy stabilise food inflation? Evidence from advanced and emerging economies. Economic Modelling, 89, 122–141.
• Catao, L. A., & Chang, R. (2015). World food prices and monetary policy. Journal of Monetary Economics 75, 69–88.
• Ginn, W., & Pourroy, M. (2020). Should a central bank react to food inflation? Evidence from an estimated model for Chile. Economic Modelling, 90, 221–234.
• Hammoudeh, S., Nguyen, D. K., & Sousa, R. M. (2015). US monetary policy and sectoral commodity prices. Journal of International Money and Finance, 57, 61–85.
• Iddrisu, A. A., & Alagidede, I. P. (2020). Monetary policy and food inflation in South Africa: A quantile regression analysis. Food Policy, 91, 101816.
• Iddrisu, A. A., & Alagidede, I. P. (2021). Asymmetry in food price responses to monetary policy: A quantile regression approach. SN Business and Economics, 1, 52.
• Portillo, R., Zanna, L. P., O’Connell, S., & Peck, R. (2016). Implications of food subsistence for monetary policy and inflation. IMF Working Paper, WP/16/70.
• Pourroy, M., Carton, B., & Coulibaly, D. (2016). Food prices and inflation targeting in emerging economies. International Economics, 146, 108–140.

2 Inflation targeting framework in emerging and developing economies: Experiences and milestones

DOI: 10.4324/9781003195368-2

Introduction

The inflationary episodes of the 1970s and parts of 1980s that struck a number of advanced economies prompted a transition to inflation targeting framework by these countries as monetary policy strategies such as the monetary targeting and pegged exchange rate regimes could not deliver the needed price stability (Svensson, 2011). Masson et al. (1997) reckon that the challenges of monetary targeting and pegged exchange rate regimes in the 1990s precipitated an exodus to inflation targeting framework by a number of advanced economies as a way to improve their inflation footprint. New Zealand was the first nation to unveil inflation targeting framework in the world in the year 1990. Other advanced countries followed...

Table of contents

• Cover
• Half Title
• Series Page
• Title Page
• Copyright Page
• Contents
• List of Figures
• List of Tables
• Preface
• 1 Introduction and background to the study
• 2 Inflation targeting framework in emerging and developing economies: Experiences and milestones
• 3 World food price paths, domestic food and overall prices and monetary policy conduct
• 4 Monetary policy and food price inflation: A wavelet-based quantile regression analysis
• 5 Summary and conclusion
• Index