Do you like food? Yes? Well, I've got some bad news. The U.S. Department of Agriculture (USDA) expects the historic drought hitting half the country to push up food inflation next year.
But it's not as bad as you might think -- the jump in food prices, that is. The drought is a once-in-a-half-century disaster amidst once-in-a-century temperatures. The chart below from the USDA puts it in perspective.
The drought has been particularly bad news for the corn crop -- with the severe dryness affecting 88 percent of it. And that's bad news for all kinds of food that either have corn in them or use corn as animal feed. That's why the USDA projects cattle and veal prices to rise more than any other food item, at a 4 to 5 percent annual rate.
Still, we're not exactly talking about Weimar-style inflation. The FDA calculates overall food prices will go up 3 to 4 percent in 2013 versus 2.5 to 3.5 percent in 2012. That's modest, but not meaningless. But there's a bigger point. The Fed can't do much about this type of inflation -- and shouldn't try to. There's a difference between prices going up because there's too much demand and prices going up because there's not enough supply. The Fed can reduce demand. It can't increase supply. It could reduce demand when supply goes down, but that means making a bad economy worse. Not the best advice.
There's a specter haunting this debate about supply shocks -- the specter of the inflationary 1970s. Back then, twin oil shocks helped send prices spiraling up at double digit annual rates. Shouldn't the Fed have raised rates then? Yes. But, as historians like to say, the past is a foreign country. Back then, stronger unions meant workers had stronger contracts -- in particular, cost-of-living-adjustment contracts. When the oil shocks sent prices up, wages automatically followed. Inflation fed on itself. Today, weaker (or nonexistent) unions mean workers have weaker contracts. When a supply shock temporarily sends oil or food prices up, wages don't follow. Inflation passes -- or, as Ben Bernanke likes to say, it's "transitory".
And so it has been, whether that was in 2008, 2011, or 2012.
Remember: When food prices start climbing faster next year, don't blame the Fed. Ben Bernanke likes food too. Some things -- like droughts -- are beyond even his control.