# **3 Government interventions during food price shocks**

In the event of large swings in global food prices, governments are confronted with difficult policy choices. One option is to allow domestic prices to adjust to world food price changes, exposing domestic consumers and producers to changes in their real incomes. Even if a sizable non-tradeable service component in the cost of providing consumers with food such as transportation, storage and retail dampens the pass-through of world food price shocks into domestic markets, allowing domestic food prices to adjust may raise inflation in the short run and, in countries where inflation expectations are poorly anchored, in the medium to long run.<sup>8</sup> Alternatively, governments can spare consumers or producers from these losses by reducing the transmission of international food price shocks to domestic markets.<sup>9</sup> As measured in this paper, policy intervention is reflected in the ratio of domestic to world prices—the “protection rate.” During a period of rising world prices, the protection rate declines when a country seeks to insulate its domestic markets from the increase in world prices. If the protection rate rises, policymakers are compounding the increase in world prices.

In practice, during the 2007-08 food price spike, close to three-quarters of EMDEs took policy action to insulate their economies from the sharp increase in international food prices (World Bank 2009). The most commonly used interventions were reductions in taxes, including import duties and consumer taxes (Figure 4).<sup>10</sup> Net importers frequently intervened by lowering import tariffs or even by introducing import subsidies, while net exporters imposed export restrictions or bans to dampen the increase in domestic prices.<sup>11</sup> 8The decline in real incomes associated with higher inflation would entail welfare losses, especially when consumers are loss- and risk-averse (Gouel and Jean 2015; Freund and Ozden 2008; Giordani, Rocha, and Ruta 2016; Easterly and Fischer 2001). In principle, monetary policy tightening can offset inflationary effects from rising global food prices to ensure that rising food prices remain a purely relative price change and do not become entrenched in higher inflation. However, this would come at the cost of reduced economic activity (Lustig 2009).

9 Policymakers may also have a longer-term goal to protect (or to tax) domestic agents (Grossman and Helpman 1994). In empirical work based on political economy models, protection rates vary to reduce both the costs associated with adjusting prices and the costs of providing a rate of protection that differs from the long-run political equilibrium (Anderson and Nelgen 2011; Ivanic and Martin 2014b).

10If countries are insulating primarily through subsidies and are fiscally constrained, their ability to insulate will be limited (Ianchovichina, Leoning, and Wood 2014).

> 11For net importers, untargeted food subsidies have implications for government revenues and fiscal space. If financed by aid, the impact on fiscal space is limited. Alternatively, targeted transfers may be more effective in protecting vulnerable groups with limited macroeconomic repercussions.

10