Monthly Labor Review August 1998 3

1996 Grain Price Shock

The Midwestern drought of 1995–96, rising foreign demand for U.S. feed grains,1and substantial commodity market speculation combined to markedly drive up feed grain

prices in 1995 and 1996. This sharp increase initiated a classic pattern for food inflation. The

price increases, especially those for corn, soybeans, and wheat, ignited the inflationary spiral

at the most basic or crude stage of processing. As

time passed, this inflationary swell spilled over

into intermediate and finished goods, culminating in an overall increase in food prices.

This article tracks an inflationary spiral in food

prices from the grain fields of the Farm Belt to

kitchen tables across America during the drought

and in subsequent months.

Mechanics of food inflation

Prices for agricultural commodities such as feed

grains are inherently volatile, because they are

susceptible to both supply and demand shocks.

Examples of supply shocks are weather- or disease-related shortcomings, or conversely, the production of bumper crops in good years. Demand

shocks usually come in the form of unexpected

purchases by foreign buyers, for example, the unexpected purchase of large amounts of American wheat in the 1970s by the Soviet Union.

Any large change in agricultural prices can

have a significant impact on the Producer Price

Index (PPI) for crude foodstuffs and feedstuffs, the

first of the PPI’s three stage-of-processing indexes

for foods. The impact of the price shock can then

pass from crude foodstuffs and feedstuffs on to

intermediate foods and feeds, and then to finished

consumer foods, along the PPI's stage-of-processing model.

As price shocks pass from one stage of processing to the next, the amplitude of the shocks

tends to diminish somewhat at each stage of processing. Chart 1 illustrates the effect of the 1995

grain price shock as it passes through the food

industry. The graph spans January of 1995

through December of 1997, and shows the percent change for the three PPI’s based on their January 1995 levels.

Because feed grains are inputs to so many food

products, higher feed grain prices can cause inflation to spread throughout almost the entire food

industry. Higher wheat costs can cause higher

flour prices, which in turn can cause higher bread,

pasta, and cereal prices. Higher corn and soybean

costs can cause higher prices for animal feeds,

cooking oil, and margarine. By affecting animal

feed prices, higher soybean and corn prices can

also have very important consequences for the

meat, poultry, egg, and dairy markets.

Late in the fall of 1995 and early in 1996, articles in major newspapers, magazines, and trade

publications began to warn about the consequences of the skyrocketing feed grain prices on

"downstream products" (intermediate goods and

finished goods; for example, flour and bread are

downstream products of wheat). Some industry

economists and media reporters projected food

inflation to be as high as 3 percent to 4 percent

(at the retail level) in 1996, and that it might surpass that of general inflation for the first time

since 1990. 2

These forecasts did in fact come

true, as the Consumer Price Index for All Urban

Consumers (CPI-U) for food and beverages rose

3.2 percent for 1996, whereas the CPI-U for all

items rose 3.0 percent and the CPI-U for all items

less food and energy rose only 2.7 percent. This

was an unusual event, as food inflation has tended

to be lower than general inflation for the past two

decades. Chart 2 depicts the percent change in the

annual averages of the Producer Price Indexes for

wheat, corn, and soybeans from 1972 through

The 1996 grain price shock:

how did it affect food inflation?

The dynamics of food inflation appear

to have changed,such that the 1996 grain price shocks

had a smaller impact than shocks in the past

Jerry Light and

Thomas Shevlin

Jerry Light is an

economist in the

Office of Prices and

Living Conditions,

Bureau of Labor

Statistics, and Thomas

Shevlin, formerly of that

office, is an economist

with the U.S. Department of the Treasury.
4 Monthly Labor Review August 1998

1996 Grain Price Shock

1996. If we define a feed grain price shock as a 20-percent or

greater increase in annual average PPI’s of at least 2 of the 3

commodities, then the data indicate that feed grain price

shocks occurred in 1973, 1974, 1988, and 1996.

These sharp increases in feed grain prices each resulted in

a surge in food inflation above the core rate 3of inflation, as

measured by both the PPI and the CPI-U. Table 1 compares the

aggregate PPI for food—finished consumer foods—to the PPI

‘core’—finished goods less food and energy. It also compares

the aggregate CPI-U for food—food and beverages—with the

CPI ‘core’—all items less food and energy.

As can be seen in table 1, food inflation at the producer

level surpassed that of core inflation in 1973 and 1974 after

the soaring grain prices of that period, and again in 1989 and

1990 after the 1988 upsurge. With the feed grain price shock

of 1995–96, food inflation again surpassed core inflation at

the producer level in 1996 and 1997. Food inflation also surpassed core inflation at the producer level in 1978, 1979,

1984, 1986, and 1993 in the absence of any significant feed

grain shocks.

At the consumer level, however, food inflation surpassed

core inflation only in 1973, 1974, 1978, 1979, 1989, 1990,

1996 and 1997. Hence, food inflation appears to be below

core inflation more stubbornly at the consumer level. With

the exception of the 1978–79 period, food inflation at the consumer level never surpassed core inflation except in the aftermath of a strong feed grain shock. Moreover, as chart 2 shows,

there were strong price increases for feed grains at the time of

the 1978–79 food inflation, although not as significant as in

the other periods.

Using a simple econometric model, we found some evidence of a statistical relationship between feed grain prices

and consumer food prices. The tests suggested that we would

expect a 100-point, 1-month increase in the feed grain index

to be associated with a 4.1-point cumulative increase in the

CPI-U for food and beverages over a 12-month period. The

tests also suggested that, in the long run, a 100-point increase

in the feed grain index should be associated with an 11.4-point

increase in the CPI-U for food and beverages, and that an increase in the CPI-U for food and beverages tends to follow an

increase in the PPI for feed grain. Hence, the tests were wholly

supportive of the theory that feed grain shocks at the producer

level can cause food inflation to rise relative to core inflation

at the consumer level. The appendix provides more details of

the models used in these tests.

General components of food inflation

A market basket of goods. In a quest to track and analyze

what the consumer pays for food products and how that price

Chart 1. Growth trends in PPI for food items, by stage of processing, 1995–97

–5

0

5

10

15

20

25

30

35

40

–5

0

5

10

15

20

25

30

35

40

0

Stage 1: Crude foodstuffs and feedstuffs

Stage 2: Intermediate foods and feed

Stage 3: Finished consumer foods

Dec.

1997

Jan. 

1995

Jul.

1995

Jan.

1996

Jul.

1996

Jan.

1997

Jul.

1997

Percent change Percent change

NOTE: The percent changes are based on the January 1995 levels. 
Monthly Labor Review August 1998 5

is established, the U.S. Department of Agriculture utilizes several concepts. One pricing concept uses a “market basket” of

goods, and aims to analyze changes in the price of food products at the retail level (CPI-U) at the grocery store, as opposed

to prices at the producer level (PPI). “The market basket contains the average annual quantities of food purchased per

household in a base period (1982–84). Since the basket relies

on a fixed set of quantities, changes in the value of the market

basket are strictly a result of changes in price.”4

The Department of Agriculture’s market basket concept relies on three components:

Retail price. “The retail price component is a subset of

the Consumer Price Index for food at home, adjusted to exclude imported foods, nonalcoholic beverages, and seafood.

Moreover, food purchased for away-from-home consumption is excluded from the estimate.”

Farm value. “The farm value represents the prices received by farmers for the quantities of raw farm commodities that must be purchased from farmers in order to sell a

unit of food product at retail.”6

Farm-to-retail price spread. “The farm-to-retail price

spread is the difference between retail price and farm value,

and represents the cost of processing, wholesaling, and retailing foods.”7

 In other words, a farm-to-market spread represents the difference between average prices at two levels

(farm and retail) of the food marketing system at a given

point in time.

Table 2 shows the percentage that farm value makes up of

the retail price of a sample of the market basket of commodities. Generally, a product’s farm value decreases as the degree

of processing required to make the product increases. For example, eggs require only grading, cleaning, packaging, and

distribution before they end up on the supermarket shelf. For

this reason, eggs had a relatively high farm value of 62 percent in 1996. In contrast, a food product that requires a high

degree of processing (an 18-ounce box of corn flakes) had a

farm value of only 7 percent. With such a low farm value, it

becomes easier to understand how the major cereal manufacturers engaged in a price war. They were able to sustain significant reductions in cereal prices in 1996 while corn and

other grain prices were at near record highs.

In the case of animal products, both the value of the animal

and of the feed it ingests (a farm product) must be considered

part of the farm value. Consequently, meat, dairy, egg, and

animal fiber products tend to have higher farm value than

products that come directly from grains or other crops. However, other factors also enter into the equation. A product

such as choice beef has a higher farm value than milk, even

•

•

•

Chart 2. Percent change in the annual average Producer Price Indexes for corn, soybeans, and wheat, 1972–96

1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996

–40

–20

0

20

40

60

80

100

120

0

–40

–20

0

20

40

60

80

100

120

Corn

Soybeans

Wheat

Percent change Percent change
6 Monthly Labor Review August 1998

1996 Grain Price Shock

though both have food and feed farm

value components. The reason is that

it takes from 2 to 3 pounds of steer to

equal l pound of choice beef. The rest

is lost in processing. In contrast, a gallon of milk from a dairy farm ends up

to be very nearly a gallon of milk at

the processed level in the grocery

store.

Orange juice concentrate, despite

having no feed component, has a relatively high farm value. Citrus industry

sources note that 12 to 15 oranges

must be processed to manufacture a

12-ounce can of concentrate.

The farm value for the market basket of goods is becoming less important as a contributor to retail price over

time. Farm value as a percentage of

retail price fell from 40 percent in

1956 to 35 percent in 1984. The decline then accelerated, and farm value

fell to 25 percent of retail pricein

1996.8

 This suggests that a price

shock at the farm level 20 or 30 years

ago would have had a much more pronounced effect on food prices than it

would now.

The portion of a finished food

product’s price that is farm value is an important issue when

considering the impact of a farm product's price change. If the

farm value is low, then the change in price of a farm product

will not have a significant impact on the cost of producing

downstream goods. In the case of bread, for example, wheat

flour is certainly an important input, but labor, capital equipment, energy, yeast, water, preservatives, packaging, shipment,

storage, and advertising represent significant costs as well. If

these other costs remain constant, the impact of flour inflation

on the total cost of bread will be relatively small. Bread producers will prefer to keep prices as steady as possible, both

because purchasers tend to resent constantly fluctuating prices

and also because constantly shifting prices can create a significant accounting burden and other costs for manufacturers.

Producers, therefore, tend to resist price changes when

changes in production costs are small. Furthermore, even very

large changes in flour prices may not significantly affect the

price of bread if the price change appears to be only temporary.

A grain shock affects a food product’s ultimate price by

driving up its farm value. As the price of a product’s farm input increases, the price of the finished product will generally

rise as well. In the case of corn flakes, the farm value was so

small that the finished good’s price fell even though the price

of the major farm input, corn, was rising substantially.

Consumer demand. While farm value and farm-to-retail

price spread are important concepts to remember when analyzing food prices, remember that changes in demand can also

play a role. The effect on food prices resulting from changes

in consumer demand is harder to quantify or calculate than

are shocks from farm value and farm price spread.

An example of how changes in consumer demand can affect prices is the increased prices of chicken wings relative to

other chicken parts. Breast meat historically has been deemed

as the most desirable part of a chicken. For that reason, prices

and indeed price growth for breast meat had surpassed those

of other chicken parts. However, in the mid-1980’s, the phenomenon of ‘Buffalo wings was born. Suddenly, the demand

(and subsequently the price paid) for chicken wings from food

service outlets and for home use turned up dramatically. According to the Department of Agriculture, the wholesale price

of chicken wings rose from 37.99 cents/lb. in 1985 to 61.79

cents/lb. in 1994, whereas the wholesale price of chicken

breasts fell from 101.48 cents/lb. in 1985 to 86.62 cents/lb. in

1994.9

 This phenomenon has continued to manifest itself

throughout the 1990s, despite some resurgence in demand for

chicken legs for export purposes.

Table 1. Comparisons of food inflation in the Producer Price Indexes (PPI) and

Consumer Price Indexes for all Urban Consumers (CPI-U), 197397

[In percent]

19731 ................. 20.50 24.6 13.20 3.60

1974 .................. 14.00 11.40 13.70 8.30

1975 .................. 8.40 11.40 8.50 9.10

1976 .................. –.30 5.70 3.20 6.50

1977 .................. 5.30 6.00 6.00 6.30

1978 .................. 9.00 7.50 9.70 7.40

1979 .................. 9.30 8.90 10.70 9.80

1980 .................. 5.80 11.20 8.50 12.40

1981 .................. 5.80 8.60 7.80 10.40

1982 .................. 2.20 5.70 4.10 7.40

1983 .................. 1.00 3.00 2.30 4.00

1984 .................. 4.40 2.40 3.70 5.00

1985 .................. –80 2.50 2.30 4.30

1986 .................. 2.60 2.30 3.30 4.00

1987 .................. 2.10 2.40 4.00 4.10

1988 .................. 2.80 3.30 4.10 4.40

1989 .................. 5.40 4.40 5.70 4.50

1990 .................. 4.80 3.70 5.80 5.00

1991 .................. –.20 3.60 3.60 4.90

1992 .................. –.60 2.40 1.40 3.70

1993 .................. 1.90 1.20 2.10 3.30

1994 .................. .90 1.00 2.30 2.80

1995 .................. 1.70 2.10 2.80 3.00

1996 .................. 3.50 1.40 3.20 2.70

1997 .................. .70 .40 2.60 2.40

 1The percent change for finished goods less food and energy for 1973 is actually the percent change for

finished goods less food, as there is no index for finished goods less food and energy before 1973. In all

other years, we excluded energy from the PPI and CPI broad-based indexes because its inherent volatility

makes its exclusion a more commonly accepted measure of ‘core’ inflation.

Year

PPI CPI-U

Finished consumer

foods

Finished goods less

food and energy

('core' inflation)

Food

and

beverages

All items less food

and energy

(core inflation)
Monthly Labor Review August 1998 7

Causes of the feed grain price shock

A combination of three factors appeared to have led to the

1996 feed grain price shock:

The 1995 drought in the Midwestern and Western regions

of the United States decreased the yields of feed grain crops,

particularly corn

Pessimistic crop forecasts, especially for wheat, fueled futures market speculation

Foreign demand for U.S. feed grains was robust

Chart 3 illustrates feed grain price trends from January

1995 to May 1997. The chart clearly shows sharp increases

in feed grains prices in the spring and part of the summer in

1996. Prices then declined to more typical ranges in the fall.

The 1995–96 drought, which gripped the Midwestern and

Western regions of the United States, had a double-edged effect on prices of feed grains during that time. As this article

will show, the drought significantly shortened supplies of feed

grains for the season, especially corn. The second component

of the drought’s effect on commodity

prices was the fueling of futures market speculation. This effect most

clearly manifested itself in the wheat

market.

Of the three principal grain commodities discussed in this article, corn

has by far the largest value of shipments in the United States, and therefore is the most heavily weighted in

the PPI for crude foodstuffs and feedstuffs aggregate index. Within this aggregate index, corn has a relative importance of 4.129 percent, soybeans

has a relative importance of 2.419 percent, and wheat has an importance of

1.428 percent.10

Corn. The soaring cost of corn was

undoubtedly the major driving force

behind the startling upsurge in animal

feed prices and had a domino effect on

downstream food product prices. The

high cost of corn not only directly affected prices of animal feed products,

but also indirectly affected prices for

beef, pork, eggs, milk, and other food

commodities made from animal product inputs. Corn is used as a feed product both in its natural state (normally

shelled from the cob) and as an input

to the manufacture of prepared feeds. According to U.S. Commerce Department data, corn was the largest component of

the $10.4 billion of materials, ingredients, containers, and supplies going into the production of $13.3 billion worth of prepared animal feeds in 1992. Important input components for

animal feed production included $2.2 billion for corn and corn

byproducts, $1.8 billion for soybean products, and only $0.4

billion for wheat and wheat byproducts.11

As noted in table 3, 1994–95 was a record year for corn

production with more than 10.1 billion bushels produced at

an average yearly price of $2.26 a bushel.12 Production fell to

7.4 billion bushels in the 1995–96 crop year and the average

price per bushel of corn shot up to $3.24 for that year. Stored

stocks fell to historic lows of 426 million bushels to end the

1995–96 crop year.13 The 26.7-percent decline in production

from the preceding year, the 75-percent reduction in stocks,

and speculation in the futures market resulted in a 43.3-percent rise in prices paid to farmers for corn, according to the

Department of Agriculture’s measure of average price per

bushel. As chart 3 shows, the PPI for corn rose considerably

over the course of the 1995–96 crop year, (from September

Table 2. Farm-value percentage of retail price for selected sample of the

Department of Agriculture market basket of commodities, 1994, 1995,1996

[In percent]

Commodity 1994 1995 1996

Eggs, grade A large (1 doz.) ................. 58 59 62

Beef, choice (1lb.) ................................. 52 49 48

Chicken, broiler (1lb.)............................ 54 53 57

Pork (1 lb.) ............................................ 32 34 38

Cheese, cheddar (1 lb.) ....................... 35 34 40

Fruits and vegetables, fresh:

Lemons, (1 lb.) .................................. 24 26 24

Apples, red delicious, (1 lb.) .............. 22 25 23

Potatoes (10 lb.) ................................ 21 21 21

Oranges, California, (1 lb.) ................. 20 19 17

Fruits and vegetables, frozen:

Orange juice concentrate (12 oz.) ..... 38 40 37

Corn (1 lb.) ........................................ 12 13 13

Green beans, cut (1 lb.) ..................... 11 11 11

Fruits and vegetables canned, bottled: .

Canned peas (17 oz.) ........................ 22 24 26

Canned corn (17 oz.) ........................ 21 28 26

Applesauce (25-oz. jar) ..................... 15 16 21

Fruits and vegetables, dried: ................

Beans (1 lb.) ................................. 36 35 31

Raisins (15-oz. box) ........................... 29 26 30

Prepared foods: ....................................

Pork and beans (16 oz.) .................... 18 20 18

Potato chips, regular, (1 lb. bag) ........ 16 18 17

Bread, (1 lb.) ...................................... 7 8 8

Corn flakes (18-oz. box) .................... 5 6 7

Corn syrup (16-oz. bottle) .................. 4 4 5

NOTE: The farm-value represents the percentage of the retail price of a commodity that is received by

farmers.

SOURCE: Howard Elittzak, Food Cost Review 1996, USDA Agriculture Economic Report No. 761 (U.S.

Department of Agriculture, 1997), t. 5, p. 7.

•

•

•
8 Monthly Labor Review August 1998

1996 Grain Price Shock

1995 through August 1996) and then fell considerably with

the beginning of the 1996–97 crop year in September 1996.

Soybeans. As shown in table 3, the drought-induced short

crop of soybeans also drove up grower prices for that commodity, just as it did for corn. Production fell from 2,517 million bushels in the 1994–95 crop year to 2,177 million bushels for the 1995–96 crop year. Grower prices jumped from

$5.48 a bushel to $6.77 per bushel. In other words, a 13.5-

percent decrease in production coincided with a 23.5-percent

increase in the Department of Agriculture's average bushel

price.15

Most soybeans are crushed in oilseed processing plants to

produce vegetable oils. These oils are major inputs to cooking oils and margarine. The byproduct of the crush is a cake

or meal used for the production of animal feed. Soybeans are

not used in raw form for food or animal feed. Accordingly,

soybean feeds and products have a lower farm value than corn

products. Consequently, the rise in soybean prices should have

a smaller impact on feed prices than did the rise in corn prices.

Wheat. The grain commodity thought at first to be most devastated in the 1995–96 drought was winter wheat. This variety represents the overwhelming majority of the Nation's wheat

production. For example, the Department of Agriculture’s data

for 1994 indicate that out of a total of 2,320,981 bushels of

wheat produced, 1,661,943 bushels, or 71.6 percent, was winter

wheat. Durum and other spring wheat accounted for only

659,038 bushels.16

Farmers plant winter wheat in autumn in the high plains of

the Midwest. In a normal year, the wheat germinates, sprouts,

and emerges from the soil to a height of a few inches later in

the fall. The crop then lies essentially dormant through the

winter months, ideally with snow cover to protect it from severely cold temperatures. In the spring, the wheat plant begins to grow and mature. The crop ripens and is ready for

harvest in the summer.

Wheat was already below normal supply due to an unusually small 1995–96 wheat crop. Because of the drought, the

winter wheat crop suffered from poor plant emergence in the

fall of 1995. The winter of 1995–96 exacerbated the problems of poor emergence, as the winter was unusually cold,

and snow failed to cover and protect the crop. “Winterkill,”

therefore, was thought to be unusually extensive. Much of the

crop was projected in early Department of Agriculture assessments to be too severely damaged to make harvesting cost

effective.

As with most agricultural commodities, feed grain trading

on commodity exchanges and prices are highly sensitive to

anticipation of a shortage. The Department of Agriculture

monitors the Nation’s crops and animal herds and forecasts

both quantity and quality of production in a series of monthly

Chart 3. Inflationary trends in the Producer Price Indexes for feed grain, January 1995 through June 1997

0

50

100

150

200

250

0

50

100

150

200

250

Wheat

Corn

Soybeans

June

1997

January

1997

July

1996

January

1996

July

1995

January

1995

Index Index
Monthly Labor Review August 1998 9

U.S. agriculture

exports (in billions)

Year

outlook reports. Early reports forecast much smaller harvests

for corn, soybeans, and wheat than was normally expected.

However, the actual harvest of these crops proved better than

the forecasts, especially for wheat.

The Department of Agriculture had been giving dire forecasts of the 1996–97 wheat crop throughout spring of 1996.

For example, in May of that year, it forecast production totals

at 2,074 million bushels,17 which would have meant a 5-percent reduction from the 2,186 million bushel near-final estimate for the 1995–96 year18. Moreover, at that time, the Department of Agriculture projected an even sharper reduction,

12 percent, in the winter wheat crop. This suggested that the

early part of the crop year would have the biggest shortage.19

It is important to realize that, because the 1995–96 wheat crop

was already small, a dearth of wheat had already begun to

develop. As the 1996–97 crop year began in June 1996, the

Department of Agriculture forecast that farmers would forego

harvesting 27 percent of the winter wheat crop,20 despite

record high wheat prices.21 The forecasted harvest of winter

wheat was the lowest since 1972.

As shown in table 3, total production of wheat (in bushels)

actually increased 4.6 percent (from 2,183 million bushels in

the 1995–96 crop year to 2,282 million bushels in the 1996–

97 period). The PPI for wheat reached a zenith in May 1996, at

the time of the Department of Agriculture’s forecast announcement, and then began to fall as the crop year progressed and

forecasts proved too pessimistic. (See chart 3.) These pessimistic forecasts appear to be the primary reason for the unusual runup increase in wheat prices at the end of the 1995–96

crop year. This rise led the 1995–96 average price per bushel

of wheat to be $4.55, a 31.6-percent increase over the previous year’s price of $3.45 per bushel. These price increases

occurred with only a 5.9-percent decline in production between the two crop years.

Part of the reason for the better-than-forecasted production in the 1996–97 crop year (particularly in winter wheat),

came in the form of “nick of time” rains in the summer of

1996. Another factor in the less-than-expected shortage of the

overall wheat crop was the increased production of spring varieties of wheat. The following tabulation shows wheat production over the 1993–96 period (in millions of bushels):22

1993 1994 1995 1996

All wheat ...................... 2,396 2,321 2,183 2,282

 Winter wheat ............. 1,760 1,662 1,544 1,478

 Percent ................... 73.50 71.60 70.70 64.80

 Spring wheat ............. 636 659 639 804

 Percent ................... 26.50 28.40 29.30 35.20

Foreign demand. At the time that feed grain prices were rising due to domestic events here in the United States, foreign

demand for U.S. feed grains was putting further upward pressure on feed grain prices. The following tabulation shows income produced by U.S. agriculture exports over the 1990–96

period:

1990 ......................... $39

1991 ......................... 39

1992 ......................... 43

1993 ......................... 43

1994 ......................... 46

1995 ......................... 56

1996 ......................... 60

U.S. food exports surged remarkably in 1995 and again in 1996. Rising

demand in developing economies and

the poor harvests abroad were the driving forces behind U.S. food exports.

Most of the increase in agricultural

exports in 1995 and again in 1996 was

in the area of feed grains. In 1995, there

was a $10.1 billion increase in U.S. agricultural exports, of which $5.8 billion

was attributed to increases in exports

of corn, soybeans, and wheat. In 1996,

there was a $4.6 billion increase in agricultural exports, of which $3.8 billion, or approximately 83 percent, was

due to corn, soybeans, and wheat.23 To

Table 3. Corn, soybean, and wheat production, 199497 and estimates for

199798

Grain 199495 199596 199697

Corn (million bushels):

Production ......................... 10,103 7,374 9,293 9,276

Total supply ........................ 10,962 8,948 9,731 10,227

Disappearance1 ................. 9,405 8,522 8,790 9,380

Ending stocks .................... 1,558 426 914 847

Price per bushel ................. $2.26 $3.24 $2.70 $2.70

Soybeans (million bushels): 

Production ......................... 2,517 2,177 2,382 2,744

Total supply ........................ 2,731 2,516 2,576 2,874

Disappearance1 ................. 2,396 2,333 2,451 2,559

Ending stocks .................... 335 183 125 305

Price per bushel ................. $5.48 $6.77 $7.38 (2)

Wheat (million bushels):

Production ......................... 2,321 2,183 2,282 2,531

Total supply ........................ 2,981 2,757 2,748 3,070

Disappearance1 ................. 2,475 2,381 2,306 2,375

Ending stocks .................... 507 376 444 695

Price per bushel ................. $3.45 $4.55 $4.35 $3.35

1 “Disappearance” includes the total demand or use of a commodity.

2

 Data are not available.

SOURCE: Compiled data from Feed Grains Outlook (U.S. Department of Agriculture, Economic Research

Service, Aug. 13, 1997), t. 1, pp. 4–5 of electronic version.

199798

(estimated)
10 Monthly Labor Review August 1998

1996 Grain Price Shock

meet the rising foreign demand for grains, the United States

largely relied on its reserves in 1995. In 1996, however, the

dollar value of U.S. agricultural exports rose again, although

the actual volume of exports remained roughly the same. With

very little left in feed grain reserves, and with the drought causing a shortage in supplies, U.S. and foreign consumers of bulk

grains were facing increasing competition for a shrinking

supply.

In 1995, exports rose both in terms of volume and dollar

value. As chart 4 depicts, the volume of grain exports surged

dramatically in 1995, but leveled for wheat and corn in 1996.

This shows that the increase in the dollar value of feed grains

in 1996 was due to the rising prices. Foreign nations were

reluctant to surrender recent increases in imports in the face

of the higher prices. The most remarkable rise in feed grain

exports was for corn.

Price shock's effect on food inflation

As with the 1973 and 1988 periods of high feed grain inflation, the 1996 feed grain price shock generated a significant

inflationary effect on downstream food products. The Producer Price Index for finished consumer foods rose 3.5 percent from 1995 to 1996, surpassing the PPI for finished goods

less food and energy, which rose only 1.4 percent.

As shown in the following tabulation, most of the increase

in the annual average between 1995 and 1996 for the PPI for

finished consumer foods came from components for which

feed grains are an important input either for manufacture or

for a source of feed :

Dairy products .................................. 1.18

Meats ................................................. .91

Cereal and bakery products.............. .44

Miscellaneous processed foods ....... .38

Processed poultry ............................. .36

Fresh fruits and melons .................... .33

Processed fruits and vegetables ....... .33

Chicken eggs..................................... .25

Confectionery end products ............. .20

Soft drinks......................................... .07

Refined sugar .................................... .01

Shortening and cooking oil .............. –.06

Unprocessed and packaged fish ....... –.09

Fresh and dry vegetables.................. –.16

Packaged beverages.......................... –.33

Chart 4. Volume of U.S. exports of wheat, corn, and soybeans, 1990–96

Product

Component impact on

the PPI for finished

consumer foods

1990 1991 1992 1993 1994 1995 1996

0

10

20

30

40

50

60

70

0

10

20

30

40

50

60

70

Wheat

Corn

Soybeans

[Millions of metric tons] Millions of metric tons

SOURCE: U.S. Agricultural Exports: Calendar Years 1990–1996 (U.S. Department of Agriculture).
Monthly Labor Review August 1998 11

As noted, dairy products; meats, cereal and bakery products; processed poultry; and chicken eggs combined accounted for a 3.14-percent increase in the PPI for finished consumer foods, and therefore accounted for about 90 percent of

the overall increase in that PPI aggregate index.

Fifty-two percent of the weight for the PPI for finished consumer foods belongs to areas that are directly affected by feed

grains, namely dairy products, meats, bakery products, flour,

other cereals, processed poultry, shortening and cooking oil,

and eggs.24 This is why feed grain prices can have such a large

impact on the PPI for finished consumer foods. Only 33 percent of the product weight belongs to products not directly

affected by feed grains, specifically: the PPI for fresh fruits

and melons, fresh and dry vegetables, processed fruits and

vegetables, unprocessed and packaged fish, milled rice, confectionery end products, soft drinks, packaged beverages, and

refined sugar. The remaining 15 percent of index weight belongs to the PPI for miscellaneous processed foods, some of

which are related to feed grains and some of which are not.

Beginning about the time of the grain price increases, inflation was generally higher over the June 1995–June 1997

period for items affected by feed grains (cereals, bakery products, meat, and processed poultry) than for the PPI aggregate

finished consumer foods. (See chart 5.) The PPI for cereals

and bakery products was above the inflationary trend for only

a short time, but PPI components meats, processed poultry, and

dairy products were well above the general inflationary trend.

The inflation in the PPI for cereals and bakery products came

first, and was not long lived after feed grain prices began to

decline. Inflation in the PPI components for meats, processed

poultry, and dairy products, on the other hand, came later and

was more persistent.

Flour and bread. As a result of the increase in wheat prices

in late 1995 through 1996, wheat flour prices began to rise.

One major flour producer, for example, raised flour prices 3.7

percent in January 1996.25 The price movement of wheat,

flour, and white pan bread is depicted in chart 6 (top panel).

As table 2 indicated, bread had a farm value of only 7 percent in 1994. Therefore, the weak relationship between wheat

and bread prices is not surprising.

Prepared animal feeds. Another area in which grain price

increases drove up prices for products downstream almost immediately is the animal feed industry. Animal feeds are not a

component of the PPI for finished consumer foods, so their

price movement did not directly contribute to the fact that food

inflation surpassed that of core inflation in 1996. However,

when faced with extremely expensive feed costs, farmers and

other producers make decisions to minimize their costs; for

example, they can scale back production. For meat, poultry,

egg, and dairy producers, scaling back production generally

means eliminating part of their herd or flock. As shown in

chart 6 (lower panel), prices for animal feeds derived from

grains shot up substantially during the first part of 1996 and

stayed at high levels for most of the year.

Cattle and beef. As feed costs increased, farmers sent a large

portion of their herds to slaughter, causing an initial decrease

in the prices of slaughter cattle and beef. (See chart 7, top

panel.) Slaughter rates began to grow significantly in the fall

of 1995 when the ramifications of the drought and high feed

grain prices became apparent to cattle producers. The culling

of the Nation’s cattle herd continued in earnest during most

of 1996, and in some respects, continued on throughout most

of 1997. The ending inventory between 1995 and 1996

dropped some 2.3 million head, as shown in the following:24

1993 1994 1995 1996 1997

Total supply (in million 141.1 143.1 145.8 145 142.2

 head)

Beginning inventory,

January 1 .................... 99.2 101 102.8 103.5 101.5

Calf crop and imports .... 41.9 42.1 43 41.6 40.7

Total disappearance ....... 39.5 40.2 41.8 43.3 43.1

Slaughter ........................ 34.7 35.7 37.3 38.6 38.1

Deaths and exports ........ 4.8 4.5 4.5 4.7 5.0

Ending inventory,

January 1 .................... 101 102.8 103.5 101.2 99.5

Farmers and ranchers traditionally bring supply pressure

to bear on the market in late fall by culling their herds to make

then a manageable size to feed through the winter and also to

take profits. But during late 1995 and early 1996, this selloff

and the resulting freefall in prices for cattle intensified due to

real and anticipated concerns about feed costs. Prices for

cattle did not begin to rebound until the early summer of 1996

when natural pasture developed; it would be mid-summer before feed prices began to fall. The initial impact of the feed

grain shortage, therefore, was that it drove down the price of

beef. However, this shortage and subsequent selloff led to

higher beef prices in the longer term, because herds take 2 to

3 years to rebuild.

Hogs and pork. The effects of drought and high feed grain

costs on pork prices are less straightforward than those for

beef. (See chart 7, bottom panel.) Because hogs are even more

dependent on feeds and feed grains than cows for their livelihood, it would be logical to expect that hog producers would

have sold off large parts of their herds rather than pay high

feed costs during the period. Indeed, the data do indicate that

slaughter hog and pork prices did start dropping in November of 1995 and remained low for several months. This resulted from higher slaughter rates. But, unlike the cattle mar-
12 Monthly Labor Review August 1998

1996 Grain Price Shock

Chart 5. Percent price changes for products directly affected by feed grains, compared with those for finished

consumer foods, January 1995 through June 1997

–4

–2

0

2

4

6

8

10

12

14

16

0

–4

–2

0

2

4

6

8

10

12

14

16

Cereals and bakery products

Meats

Processed poultry

Finished consumer foods

-20

-10

0

10

20

30

-20

-10

0

10

20

30

Dairy 

products Fats and 

oils Finished consumer 

foods

Cereals and bakery products, meats, and processed poultry

Dairy products and fats and oils

Jan.

1995

June

1995

Jan.

1996

June

1996

Jan.

1997

June

1997

Jan.

1995

June

1995

Jan.

1996

June

1996

Jan.

1997

June

1997

Percent

change

Percent

change

Percent

change

Percent

change

NOTE: The data in this chart depict the percentage change in the Producer Price Indexes above their June 1995 levels. 
Monthly Labor Review August 1998 13

Chart 6. Transmission of wheat inflation to bread and corn and soybean inflation to animal feed, January 1995 to

June 1997

–10

0

10

20

30

40

50

60

70

0

–10

0

10

20

30

40

50

60

70

Wheat (PPI)

Flour (PPI)

White pan bread (PPI)

White bread (CPI)

–25

0

25

50

75

100

125

150

–25

0

25

50

75

100

125

150

Corn

Soybeans

Prepared animal feeds

Percent

change

Jan.

1995

June

1995

Jan.

1996

June 

1996

Jan.

1997

June

1997

Percent

change

Percent

change

Percent

change

Jan.

1995

June

1995

Jan.

1996

June 

1996

Jan.

1997

June

1997

Corn and soybeans

Wheat inflation
14 Monthly Labor Review August 1998

1996 Grain Price Shock

ket, prices for slaughter hogs and pork began to rise sharply

in February of 1996, and did not begin to drop until September. This was due in large part to strong export demand. Prices

being offered for pork products actually overwhelmed the increased feed costs and kept positive returns coming in for most

hog producers.

Dairy products. Prices for dairy products and for fluid milk

also rose during the summer and fall of 1996, slightly lagging

the increase in feed prices. (See chart 8, top panel.) Sources

from the Department of Agriculture indicate that the impetus

for increased prices for dairy products was twofold.27 First,

supply shortages arose when many producers tried to reduce

their feed costs by sending some of their milking herds to

slaughter, and many of the remaining milking cows produced

less because farmers gave them less feed. Secondly, there was

a significant increase in export demand for dairy products.

Poultry and eggs. Due to life span differences, it takes less

time to rebuild the Nation’s chicken flock than it does to restock the cattle and dairy herd. The effects of any sell off,

resulting in a short-term glut in slaughter-flocks and longer

term supply shortages of poultry, meat, and egg products,

should pass through the economy more quickly than those for

beef and dairy products.

The fierce summer heat of 1995 decimated a significant

portion of the Nation’s layer flock (chickens reserved for laying eggs). Many producers were reluctant to rebuild their individual flocks when they witnessed the rising feed costs. The

decreased production was at least partly responsible for the

increase in egg prices.

In January 1996, a major processor of chickens estimated

that it would have to spend in excess of $125 million more

during the first half of 1996 for chicken feed than it did for

the same period in 1995. According to The Wall Street Journal, the processor indicated that it would pass some of that

cost increase to the consumer by charging higher prices for

processed chicken.28 The rise in chicken feed costs and the

resulting increase in slaughter chicken prices is evidenced in

chart 8 (bottom panel).

 Mitigating factors

Various reports from the Department of Agriculture and anecdotal evidence have suggested that the 1996 feed grain

shock did not have as strong an impact on food inflation as

shocks in the past. Research suggests that this was principally

due to three important changes in the economics of the food

industry: 1) the declining importance of farm value, 2) the

1996 Farm Act, and 3) the greater ability of foreign producers to fill the gaps in the U.S. market.

At each stage of processing, the relative importance of the

farm portion of a product’s input declines. Hence, the price

shock should diminish at each stage. As farm value declines,

the impact of grain shocks has a smaller impact on total production costs, and therefore has less ability to spark food inflation. As chart 9 shows, farm value and farm-to-retail spread

tended to closely follow each other after 1984. Using a vector

error correction model and a Chow test, we found statistical

evidence that the relationship between prices for corn, soybeans, and wheat and finished food prices weakened after

1984, when farm value began to decline sharply. (See the appendix for details.)

The 1996 Farm Act, also known as the Federal Agriculture Improvement and Reform Act or the “Freedom to Farm

Act,” removed many of the Government restrictions on agricultural production. The act deregulated the production of

most major crops, including wheat, corn, and soybeans. Under the plan, farmers still receive some subsidies, but are generally free to decide what and how much to plant. This deregulation of farming allows farmers to react to ‘price signals,’

that is, it allows them to respond to rising prices by producing

more, and to falling prices by producing less. This was also

part of the reason for the increase in the 1996–97 spring wheat

crop. Formerly, the Department of Agriculture established

production quotas, and regular market forces were unable to

correct a market shortage or glut. Farmers’ greater discretion

in planting now allows them to produce those goods in highest demand, which should tend to mitigate the inflationary

impact of a shortage.

A Department of Agriculture report discussed the impact

of the 1996 Farm Act on containing the effects of the 1996

grain price shock stating: “The 1996 Farm Act quickly and

dramatically changed the decisionmaking environment for

farm operators, landowners, and managers ...[F]arm operators and managers have taken advantage of the elimination of

acreage limitations to adjust their crop mixes. The value of

now-predictable program payments (production flexibility

contract payments) showed up in ... reports of higher land

prices, higher rental rates, and changes in the provisions of

leasing arrangements.”29

The most significant reaction by farmers to higher prices

appears to have been their growing of more soybeans. As

noted in chart 3, the price spikes in corn and wheat dissipated

by the fall of 1996, but soybean prices still remained quite

high in the fall of 1997. “U.S. soybean acreage planted in 1997

is the largest in 15 years and the third highest on record, according to USDA's Acreage report released June 30, 1997.

Moreover, it marks the first time that U.S. soybean planted

acreage has surpassed wheat plantings.”

Greater ability of foreign producers to react to market signals played a significant role in containing the grain shock as

well. Although export markets may have exacerbated the U.S.

food inflationary trend by increasing demand when domestic

stores were already low, other developments in overseas agricultural markets also are working to counteract the trend. De-
Monthly Labor Review August 1998 15

Chart 7. Growth in beef and pork inflation, January 1995 through June 1997

–20

–15

–10

–5

0

5

10

–20

–15

–10

–5

0

5

10

Slaughter cattle (PPI)

Beef and veal (PPI)

Beef and veal (CPI)

Jan.

1995

June

1995

Jan.

1996

June 

1996

Jan.

1997

June

1997

Percent

change

Percent

change

Jan.

1995

June

1995

Jan.

1996

June 

1996

Jan.

1997

June

1997

Percent

change

Beef

Pork Percent

change

–10

0

10

20

30

40

50

60

70

80

–10

0

10

20

30

40

50

60

70

80

0

Slaughter hogs (PPI)

Pork (PPI)

Pork (CPI)
16 Monthly Labor Review August 1998

1996 Grain Price Shock

Chart 8. Dairy and poultry inflation from feed to retail, January 1995 through June 1997

–10

0

10

20

30

40

–10

0

10

20

30

40

Fluid milk (PPI)

Dairy products (PPI)

Dairy cattle feeds, supplements and concentrates (PPI)

Dairy and related products (CPI)

Jan.

1995

June

1995

Jan.

1996

June 

1996

Jan.

1997

June

1997

Percent

change

Percent

change

-10

0

10

20

30

40

50

60

0

-10

0

10

20

30

40

50

60

Poultry feeds

Saughter poultry

Processed poultry

Poultry

Percent Percent

Jan.

1995

June

1995

Jan.

1996

June 

1996

Jan.

1997

June

1997

Dairy

Poultry
Monthly Labor Review August 1998 17

regulation of agriculture and falling trade barriers in other nations like Australia and Argentina have allowed farmers in

those nations to fill in the gap caused by the U.S. drought and

rising overseas demand. With world grain prices exceptionally high, such exporting nations stepped up production, especially in wheat.31

The foreign increase in wheat production was so strong

that the Department of Agriculture projected the volume of

U.S. wheat exports to decline 23 percent in the 1996–97 season from the previous year. The Department of Agriculture

cited the cause of the export decline to be “increased output

by several major exporters (Australia, Argentina, Canada, and

the EU [European Union]) and importers (China and North

Africa).”32 The higher wheat prices apparently led to a 5-percent increase in foreign wheat acreage, the largest increase

since the Department of Agriculture started tracking foreign

wheat acreage in 1960.33

 Conclusions

As we have seen, the 1995–96 runup in grain prices did affect

food prices. Food inflation surpassed core inflation in 1996

and 1997. However, it is difficult to say whether this would

have been the case if not for the robust export demand for

both grain and processed food products that manifested itself

at the same time.

Significant price fluctuation for agricultural commodities

will continue so long as there are supply shocks brought about

by adverse weather conditions, temporary shortages in labor

and equipment, and a host of other reasons. Grocery shoppers will occasionally experience sticker shock, particularly

for items such as fresh vegetables after a freeze in Florida or

a flood in California. Demand shocks from unexpected export markets (as was the case in 1973 with the Soviet Union

grain purchases) will probably always be with us as well.

Among recent demand shocks are the outbreaks of “mad cow”

disease in Britain and swine diseases in Taiwan, which created strong demand for U. S. beef and pork products.

The economics of food inflation are clearly changing for a

number of reasons. One way in which the dynamics of food

inflation has changed is that the price that we pay for food has

become less dependent on what price the farmer receives. The

farm value portion for food costs has trended downward for a

number of years, and there is no apparent reason to believe

that the trend will reverse itself.

Another way in which the dynamics have changed is that

agribusiness has become more concentrated, leading to increased economies of scale.34 The accompanying slower rise

in per unit production costs and the presence of competition

have further reduced the impact of farm supply shocks on food

inflation.

Chart 9. Comparison of retail price, farm value, and farm-to-retail spread, 1960–94

1960 1970 1980 1990 1994

0

100

200

300

400

500

600

0

100

200

300

400

500

600

Retail price

Farm value

Farm-to-retail spread

Index Index
18 Monthly Labor Review August 1998

1996 Grain Price Shock

OVERALL, FOOD INFLATION appears to have grown more stable

over time. Farmers’ responsiveness to price signals has reduced commodity price shocks. At the same time, declining

Footnotes

1

 Feed grains (as used in this article) are grains that are inputs to food and

animal feeds. The predominant feed grains are corn, soybeans, and wheat.

‘Cash grains,’ ‘bulk grains,’ and ‘grain commodities’ are all synonymous

with feed grains.

2 Scott Killman and Richard Gibson, “Big Grain Rally Seeds Food Price

Rise,” The Wall Street Journal, Jan. 26, 1996, p. A2.

3

 “Core inflation” is inflation measured by the broadest aggregate minus

food and energy prices. Therefore, the CPI core is the CPI-U for all items less

food and energy, and includes all goods and services measured by the CPI-U

except those two items. The PPI core is the PPI for finished goods less food

and energy, and includes all finished goods (except construction and horticulture) in the mining, manufacturing, and agricultural sectors that are not

food or energy goods.

4

 Howard Elitzak, “USDA Agricultural Economic Report,” Food Cost

Review, 1996 (U.S. Department of Agriculture, December 1997), p. 6.

5 Ibid.

6 Ibid.

7 Ibid.

8 Ibid. table 4, p. 5.

9 Poultry Yearbook: 1995, Statistical Bulletin No. 927 (U.S. Department

of Agriculture, Economic Research Service, December 1995), pp. 93–97, t.

98 and 100.

10 These figures represent the relative importance of component series in

the PPI by stage of processing, December 1996.

11 “1992 Census of Manufacturers,” Grain Mill Products—Industry Series (U.S. Department of Commerce, June 1995), table 7, page 29.

12 Feed Outlook Report (U.S. Department of Agriculture, Economic

Research Service, Aug., 13, 1997), table 1 of the electronic copy. Internet

address: http://mann77.mannlib.cornell.edu/reports/erssor/field/fds-bb/

feed_outlook_08.13.97c.

13 ibid.

14 ibid.

15 Oil Crops Outlook Report (U. S. Department of Agriculture, Economic Research Service, Aug. 13, 1997), pp. 4–5, t. 1 of the electronic

copy. Internet address: http://mann77.mannlib.cornell.edu/reports/erssor/

field/ocs-bb/oil_crops_outlook_08.13.97c

16 Wheat Situation and Outlook Yearbook (U.S. Department of Agriculture, Economic Research Service, March 1997), p. 47, t. 3d.

17 The U.S. Department of Agriculture made this forecast on May 10,

1996. Also, the crop year for wheat begins June 1, and begins August 1 for

corn and soybeans.

18 Agricultural Outlook (U. S. Department of Agriculture, February–July

1996).

19 “Field Crop Overview,” Agricultural Outlook (U. S. Department of

Agriculture, June 1996).

20 Winter wheat planted in the fall of 1995 would be harvested in the

1996–97 crop year.

21 Edward Allen, “Weather Problems Beset US Winter Wheat Crop,”

Agricultural Outlook (U.S. Department of Agriculture, June 1996), p. 5.

22 Wheat Situation and Outlook Yearbook (U.S. Department of Agriculture, Economic Research Service, March 1997), p. 47, t. 3.

23 “US Agricultural Exports, calendar years 1990–1996,” (U.S. Department of Agriculture).

24 The numbers for this tabulation do not sum to the exact annual average

show in PPI table due to rounding. Also this text tabulation uses the relative

importance of items as of December 1996.

25 Killman and Gibson, The Wall Street Journal,1996.

26 USDA Cattle Reports (U.S. Department of Agriculture, Jan. 31, 1998),

Electronic versions available at: http://mann77..mannlib.cornell.edu/reports/

nassr/livestock

27 Agriculture Outlook (U.S. Department of Agriculture, July 1996), p.

29.

28 Killman and Gibson, The Wall Street Journal, 1996.

29 “Managing Farm Resources Under the New Farm Act” Agricultural

Outlook (electronic edition) (U.S. Department of Agriculture, Economic

Research Service, July 24, 1997).

30 “Commodity Briefs: Field Crops,” Agricultural Outlook (electronic

edition) (U.S. Department of Agriculture, Economic Research Service, July

24, 1997).

32 “Australia’s Farmers Watch World Prices,” Agricultural Outlook (U.S.

Department of Agriculture, Economic Research Service, January–February

1997), pp. 14 and 15; and “Argentina and Brazil: Key Players in New Trade

Bloc,” Agricultural Outlook (U.S. Department of Agriculture, Economic

Research Service January–February 1997), pp. 23–27.

33 Field Crops Overview, Agricultural Outlook, 1996, p.3.

34 “U.S. Agricultural Outlook for 1997,” Agricultural Outlook (U.S. Department of Agriculture, Economic Research Service, April 1997), p. 3.

35 “Food Prices Forecast Up 2.5-3.0 Percent in 1997” Agricultural Outlook (U.S. Department of Agriculture, Economic Research Service, April

1997), p. 24.

farm value has reduced the impact that a commodity price

shocks have. This suggests that grain price shocks may have

a diminished impact on retail food prices in the future.

Appendix: Types of testing models

To investigate the effects of feed grain prices on the price of consumer food, the authors constructed a vector-autoregression model.1

The first step in constructing the model was to take a simple average

of the monthly index levels of the PPI’s for corn, soybeans, and wheat.

The authors then named this the ‘feed grain’ index and tested for a

relationship between it and the CPI for food and beverages. To control for general inflation, the authors included the CPI for all items

less food and energy (the CPI core index). The vector autoregression

model therefore included the three time series (the feed grain index,

CPI for food and beverages, and the CPI for All Items Less Food and

Energy) and a constant. The authors used monthly index levels over

the 1967–97 period.

To test for the stationarity of the data, the authors used Augmented Dickey-Fuller tests with four lags. The test failed to reject
Monthly Labor Review August 1998 19

the null hypothesis of nonstationarity for the index levels of all three

series at the 95-percent level of confidence. The test did reject the

null hypothesis for the first difference of all three series. The authors

therefore proceeded as though the three series were first difference

stationary in the first two movements.

To create the model with the most appropriate number of lags,

the authors employed the Schwarz Information Criterion. This

method found that a model with 12 lags had the best fit. The authors

therefore employed a vector autoregression of 12 lagged endogenous

variable coefficients.

To determine whether the time series were cointegrated, the authors applied a Johansen Cointegration Test. The test found that the

series were cointegrated with a rank of 1. The authors therefore constructed a vector error correction model with one cointegrating equation, the three endogenous variables, 12 lags, and a constant.

The results of the model supported the hypothesis that the feed

grain index tends to have a positive relationship with the CPI for food

and beverages, controlling for core inflation. An F-test, testing for

the joint significance of the 12 lags of the feed grain index on the CPI

for food and beverages had a significant value at the 95-percent level

of confidence. The sum of the coefficients of the 12 lags of the feed

grain index on CPI for food and beverages was +0.041.

In addition, the cointegrating equation suggests a long-term

equilibrating relationship of the form:

CPI for food and beverages =

3.772 + 0.832 CPI core + 0.114 feed grains

Furthermore, a pair-wise Granger Causality test found feed Grains

to Granger-cause CPI: food and beverages at the 95-percent level of

confidence. (Pair-wise tests also found CPI: food and beverages to

Granger-cause CPI: all items less food and energy and found that CPI:

all items less food and energy to Granger-cause CPI: food and beverages. No other pair-wise tests suggested Granger Causality.)

The regression analysis, therefore, was wholly supportive of the

hypothesis that an increase in feed grain prices tends to increase the

price for retail food prices, over some time lag. The sum of the lagged

coefficients of feed grains on the CPI for food and beverages was

both positive and jointly significant. Moreover, the cointegrating

equation established that in the long run, a 1-point increase in feed

grains should be associated with an-.11 point increase in the CPI for

food and beverages. Finally, the authors found that feed grains does

Granger-cause the CPI for food and beverages.

To test for the stability of the model over time, the authors employed a Chow test. The test looked at whether the relationship of

the vector error correction model remained constant over two subintervals; February 1968 through December 1984 and January 1985

through December 1997.2

 The test rejected the hypothesis that the

coefficients were the same for feed grains and core consumer inflation on the CPI for food and beverages at the 95-percent level of confidence. The vector error correction models, for the first, period gave

a cointegrating equation coefficient of 0.10 and a sum of lagged coefficients of 0.047 for feed grains on CPI for food and beverages. For

the second period, the results were 0.05 for a cointegrating equation

coefficient and 0.023 for lagged coefficients. The test therefore does

offer support for the hypothesis that the relationship between feed

grain inflation and consumer food inflation has weakened since

1984.

Footnotes to the appendix

1 The methodology employed follows that used by Todd E.Clark, “Do

Producer Prices Lead Consumer Prices?” Economic Review (Federal Reserve Bank of Atlanta, 1995), and also that of S. Brock Blomberg and Ethan

S. Harris, “The Commodity-Consumer Price Connection: Fact or Fable?”

Economic Policy Review, (Federal Reserve Bank of New York, October

1995).

2

 Due to differencing and the use of 12 lags in the model, the number of

observations was abridged such that the first observation was Feb 1968.