Commodities aren't just those precious metals and liquids. They also include things like sugar and coffee beans, the basic ingredients for that 31-ounce cup of coffee you get daily from Starbucks. But what you don't know is that when you buy that giant cup of java, only a very small portion of what you spend actually covers the price of the commodities (sugar, coffee beans, etc.) that went into your drink.
So what are you mostly paying for if not the basic ingredients? A huge chunk of what you pay actually goes to other things such as taxes, labor, and of course, the company's PROFITS! This holds more truth in developed countries than anywhere else. You see, commodities only make up a small amount of the total cost of food in developed countries. So basically, if commodity prices rise, it tends to just have a small impact on the prices of food... in developed countries.
But this isn't the case in emerging nations. Commodities comprise a larger portion of the total cost of food in emerging countries. In other words, food prices are more likely to mimic commodity prices.
Studies also show that consumers in developing countries also spend a greater percentage of their total income on food. So it's likely that people living in fast-growing emerging countries will feel the added price pressures (a.k.a. INFLATION) more than those living in developed countries.
So we've established that when commodity prices are rising, it could lead to stronger inflationary pressures. What could this mean for monetary policy?
Central banks usually combat hot inflation with higher borrowing rates, but in the euro zone's case, a hike in interest rates would further weigh on the region's already shaky economic recovery. Just imagine raising the borrowing rates in Greece and Ireland! Those economies have enough financial problems on their plates without the additional burden of lower GDP growth.
And the trouble doesn't stop with the euro zone. The U.K. might run into some trouble if the BOE decides to hike rates during these uncertain time, as the U.K. economy is also wrestling with low consumer demand and bleak economic growth prospects.
It's a good thing that monetary policy isn't the only solution. Emerging economies have been quicker at getting creative in handling rising food prices. India, for one, extended its bans on exporting cooking oil; South Korea has lowered its import tariffs on some food items; and Indonesia has been encouraging its locals to plant more food.
The recent upsurge in commodity prices might look a lot like history repeating itself, but that doesn't mean that we have to use the same tricks to tackle the problem. More options are available to policymakers today, which means that there is a bigger chance of solving them in a shorter amount of time.