Without a hearty demand to drive inflation, prices have drifted like a ship at slack tide, pushed by the unpredictable ebb and flow of supply-side developments. This fall, the push comes in the form of corn. America’s abundant corn crop may drive inflation further below the Fed’s official 2 percent target, and many are asking exactly how a single crop can have such a powerful affect.
Economists typically ignore the fickle prices of fuel and food sectors when calculating inflation, and for good reason: commodities shortages are typically caused by droughts, blights and wars—issues unrelated to Federal Reserve policies. For the most part, supply disruptions come and go, and their influence disappears as soon as the crisis is resolved (e.g., the closure of Gulf Coast refineries following Hurricane Katrina). Occasionally though, lengthy high prices in crucial commodities are capable of causing a sustained effect on inflation and requiring action from the Fed (e.g., the end of cheap oil in the 1970s).
This fall, a record corn harvest will threaten to push inflation into negative territory. U.S. farmers are harvesting a record yield, and regulatory changes will further increase the corn supply. Meanwhile, the volume diverted to ethanol refineries has finally reached its legislative cap, consuming an astonishing 37 percent of America’s crop.
Should we be concerned? Many economists agree that the corn harvest’s influence on inflation isn’t a problem in itself, but like a mirror, it’s showing us a different problem—the weakness of American demand.
Economists are more concerned by inflation caused by climbing aggregate demand, rather than the supply side (in this case the supply of corn). An unchecked rise in consumer spending is capable of causing a huge spike in inflation, and theoretically, as a booming economy nears its full potential of productive capacity, it could “overheat.” Ideally, the Fed should use its power to set interest rates to control economic growth—maintaining full employment and heading off inflation.
With workforce participation at historic lows—and as many as 8 million workers unemployed, underemployed, discouraged, or involuntarily part time—the economy hardly seems to be closing in on its full productive capacity. If inflation is defined as “too much money chasing too few goods,” the past five years have demonstrated the limits of monetary policy—the Fed took unprecedented actions, but the supply of money actively “chasing” goods (i.e., demand) remains scarce, and the economy is running far beneath its potential capacity.
The upside? Abundant corn supplies will lower the price of a variety of foodstuffs—from cereals to soft drinks and ground beef—but the resulting dip in inflation should not spark concerns that the economy is stalling. Lower corn prices will do nothing to disrupt the steady—if slow—pace of growth in employment and GDP. The Fed has indicated that the labor market will guide its actions, and Chair Yellen is unlikely to be spooked by the passing effect of an unusually large corn harvest.