The Impact of Rising Fuel Prices on Food Prices

In the past two years, the index of food prices has nearly doubled in nominal terms, increasing by 82%. The Inflation of food prices is due to several factors: higher energy prices, income growth, climate change and increased bio-fuel production. Income and per capita consumption is increasing in developing countries and, therefore, IT seems that a fundamental change in supply and demand is behind the current price inflation of food. Bio-fuel policies in developed countries are also a key factor behind the growing demand. Over 40% of the increase in global maize consumption from 2000 to 2007 was due to the use of bio-fuels in the United States. The overall change in the supply of and demand for food has had predictable price effects that have been further complicated by the rising cost of non-renewable resources. Therefore, the combination of factors driving food prices has led to a growing consensus that the inflation of food prices is more a structural phenomenon than a cyclical one. The reason for the greater effect of oil and energy prices on food prices from oil and energy prices stems from the relative importance of energy throughout the marketing chain, food production, transportation, processing, and distribution.
Hence, this paper analyses the adjustment of cereal prices in response to shocks in crude oil prices. To that end, an econometric framework based on the threshold cointegration approach is used. We follow a two-step methodological approach. First, we use Gonzalo and Pitarakis’s procedure to test for the presence of regime specific nonlinearities within cointegrating relationships between prices. Second, we estimate a Threshold Vector Error-Correction Model (TVECM) and the corresponding non-linear impulse response functions are calculated. Weekly data of Cereals (Maize and Wheat)  and Crude oil (DP) prices for 1998-2008 are used.