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Blog by Michael Langemeier, Center for Commercial Agriculture, Purdue University

Most of the recent discussion involving input price changes in U.S. production agriculture has focused on fertilizer prices. For example, a recent farmdoc daily article (Schnitkey et al., 2022) discussed high fertilizer prices in the context of the Ukraine-Russia conflict. Numerous factors are responsible for the surge in fertilizer prices.

Each input used in production agriculture and in other industries has its own set of supply and demand fundamentals. However, input prices can also be affected by changes in general inflation. This article compares and contrasts trends in general inflation with input price changes in U.S. production agriculture.

Long-Term Relationships
Before discussing long-term relationships between general inflation and farm input prices, it is important to define key terms. Inflation represents the decline in purchasing power of a currency over time (Investopedia, 2022). Quantitative estimates of the rate of inflation are typically made by examining the increase or decrease in the price levels of a basket of selected goods. Inflation measures include the consumer price index and implicit price deflators.

Though computed using different methodologies, inflation measures are highly correlated over time. Most economists would agree that an increase in the supply of money is the root cause of inflation. Inflation mechanisms can be classified into three types: demand-pull inflation, cost-push inflation, and built-in inflation (Investopedia, 2022). When an increase in the money supply increases overall demand more than the productive capacity of an economy, we have demand-pull inflation. When production costs increase prices, we have cost-push inflation.

Quality improvements and technological change are often incorporated into cost-push inflation. Quality improvements would increase prices while technological change tends to reduce prices. Finally, when individuals expect current inflation rates to continue in the future, we have built-in inflation. In general, the longer above average inflation rates persist, the more important built-in inflation becomes. All three of these types of inflation mechanisms are contributing to the recent surge in inflation.

It is important to note that inflation has been particularly high in the U.S. compared to other countries. A recent publication from the Federal Reserve Bank of San Francisco discusses why this is the case (Jorda et al., 2022). According to the authors of the article, recent increases in inflation in the U.S. are due to problems with global supply chains and changes in spending patterns due to COVID-19 as well as fiscal support measures designed to counteract the economic effect of the pandemic (i.e., demand-pull inflation).

As noted above, input price changes in production agriculture and other industries are due to general inflation and its mechanisms as well as supply and demand fundamentals specific to a particular input. Having said that, some inputs are more closed aligned or correlated with general inflation than other inputs.

Using information for the 1973 to 2021 period from the Federal Reserve Bank of St. Louis on inflation rates and farm input price indices from USDA-NASS, we examined the correlation between the implicit price deflator for personal consumption expenditures and agricultural production items (i.e., general input price index for production agriculture), feed, seed, fertilizer, fuels, labor, and machinery.

The correlation coefficient between the implicit price deflator and agricultural production items was 0.594. The average annual rate of change over the period was similar for the implicit price deflator and agricultural production items (approximately 3.5 percent). The average annual price changes for labor (4.4 percent) and machinery (5.1 percent) were significantly higher than the average increase in the implicit price deflator. In terms of the six specific input categories examined, the only correlation between the implicit price deflator and the input price change that was not significantly different from zero was the correlation between the implicit price deflator and feed prices.

The correlations between the implicit price deflator and labor and machinery were relatively higher than the correlation between the implicit price deflator and general farm price index (i.e., agricultural production items). This is an important result because it suggests that input prices for labor and machinery more closely follow trends in general inflation than input prices for items such as feed, seed, fertilizer, and fuels.

Relative variability can be measured using the coefficient of variation which is computed by dividing the standard deviation by the average. The coefficient of variation for the rate of change in agricultural production items was almost double the coefficient of variation for the implicit price deflator.

The coefficients of variation for feed, fertilizer, and fuels were higher than the coefficient of variation for the more general farm input price index (i.e., agricultural production items). The input price index for labor was smaller than the coefficient of variation for general inflation.

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