Are food prices becoming more volatile? Yes, says the FAO (but it doesn't know what to do about it)

The latest in the excellent two pagers from the FAO’s ‘Economic and Social Perspectives’ series looks at price volatility in agricultural markets. It finds that over recent decades, staple food prices have indeed become more volatile. The graph shows a measure of volatility – the market’s expectation of how much the price of a commodity FAO price Volatilitymight move in future. The two pager doesn’t say where the data comes from (and the paper on which it is based isn’t out yet), but it seems to measure subjective expectations, a bit like business confidence indices.

As the paper points out, a bit of price volatility is a good thing – it’s part of ensuring that supply shifts in response to changing demand, but excessive, or excessively short-term price swings deters farmers or companies from investing – especially given the timelag between investing in a new crop, and harvesting it.

Why has volatility increased?

“Increased vulnerability is being triggered by an apparent increase in extreme weather events and a dependence on new exporting zones, where harvest outcomes are prone to weather vagaries; a greater reliance on international trade to meet food needs at the expense of stock holding; a growing demand for food commodities from other sectors, especially energy; and a faster transmission of macroeconomic factors onto commodity markets, including exchange rate volatility and monetary policy shifts, such as changing interest rate regimes.

What is more, financial firms are progressively investing in commodity derivatives as a portfolio hedge since returns in the commodity sector seem uncorrelated with returns to other assets. While this ‘financialisation of commodities’ is generally not viewed as the source of price turbulence, evidence suggests that trading in futures markets may have amplified volatility in the short term.”

Alas the ‘so what’ section of the paper does not live up to the diagnosis, merely calling for better coherence and coordination between different institutions (governments, multilaterals etc), transparency and monitoring, safety nets and faster disbursing funding during price shocks – an even more restricted menu than Robert Zoellick’s recent FT piece. The FAO seems to be accepting growing volatility as inevitable and merely trying to cushion the impact a bit.

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4 Responses to “Are food prices becoming more volatile? Yes, says the FAO (but it doesn't know what to do about it)”
  1. The, now mostly defunct, Common Agricultural Policy was aimed at guaranteeing at least agricultural self-sufficiency for the EU.

    It was a reaction to the European famine at the end of World War II.

    As the risk of famine receded, what was originally seen as an externality: higher internal prices for food and dumping of excedents on the world market, became the main effect.

    It seems self evident that the global policy of self reliance on agricultural commodities made the global market a market for excedents. Meaning reserves, low prices, overproduction.

    Now we consider food less as a strategic issue and more as a commodity, I would guess that of course volatility goes up.

  2. p baker

    Yes – ‘So What?’ Food prices are higher, surely that’s the main point. Volatility of financial instruments is something else. I can’t see why FAO should be so interested in this, they should be concentrating on helping farmers grow more food. Something for the new DG to consider?

  3. Masuma

    Hi Duncan,
    i tend to get uncomfortable when people start talking about ‘volatility’ as if its a bad thing; are we talking amplitude or frequency? if the amplitude has gone down but now occur in a shorter time span, that’s ok… its just a reflection of the price markets reacting more quickly than the supply markets. if its about larger amplitudes, well that may be a problem. in base metals, although volatility has increased, the amplitudes are smaller, just the frequency has gone up.
    besides i thought higher prices were an incentive enough to seriously start investing in agriculture again. that’s a good thing… right?

  4. Julian Roche

    Hi Duncan,

    I’m pleased you recognise that derivative markets do not create price volatility (there are some excellent academic studies to the contrary, in fact – e.g. when the Hong Kong authorities withdrew off-plan buying (and selling on) price volatility increased.

    But what would you and your NGO colleagues actually like to see in terms of price risk management, if what the World Bank has to say is just a free market mantra? Are you against promoting the use of market risk management instruments like options by farmers? That is what the World Bank wants to happen, after all.

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