Many people like Sgt. Joe Friday’s approach to economic issues: ‘Just the facts, ma’am.’ The problem is that individual cold, hard facts, taken in isolation, often mislead. People like certainty and simplicity. But real life is uncertain and complicated.
Consider two statements about monetary policy. First, the Federal Reserve raised interest rates an unprecedented 17 times since 2004. Second, over the past three years, the Fed raised interest rates from near-record lows back to the range that has prevailed over the last 20 years.
Both these statements are factually true. Each however, taken by itself, conveys a very different message about Fed policies.
Similarly, the U.S. dollar buys a third fewer euros than it did in October 2000. That shocks some. Compare it with when the euro was introduced eight years ago and the cumulative decline is only 10 percent, a less alarming drop.
When something changes one often must frame it in both absolute and relative terms to understand what is going on. Consider Mexico’s ongoing tortilla crisis.
Corn tortillas prices rose sharply over the last year. U.S. corn prices also rose over the same time. Therefore many conclude, high corn prices are driving up the cost of food for the poor.
This is a particularly attractive conclusion for those who worry that increased ethanol use will increase hunger by sharply boosting grain prices.
Corn prices indeed have risen very sharply. Current prices at local elevators across the Corn Belt are about twice as high as in January 2006. Increased corn use by ethanol distilleries seems a major factor in this price rise.
Tortilla prices increased nearly 20 percent. If corn prices have doubled, this surely must be the cause. Ergo, ethanol is starving the poor.
In isolation, the relative increase in corn prices is misleading, however. Consider absolute prices. Country elevator prices increased from roughly $1.75 to $3.60 per bushel over the last year. On a per-pound basis, corn increased from 3.3 cents per pound to 7.3 cents.
Tortilla prices rose from some 34 cents per pound to 41 cents. So U.S. corn price increases did equal about half the rise in tortilla prices. But raw corn is only a fifth of the total cost of a tortilla.
There is more to the story, however. Just as the Fed’s rate increases were from an abnormally low base, so was the rise in corn prices.
In May 1996, when U.S. consumer prices were 23 percent lower than they are now, corn prices briefly hit $4.66. Over the last decade, they averaged about $2.20. In historical context, recent price increases are not as dramatic as they seem.
Moreover, as U.S. corn prices drifted lower from 2003 to 2006, there was no corresponding decrease in Mexican tortilla prices. Something is going on besides the ethanol boom.
It would be nice if a crystal clear cause-and-effect stared us in the face every time something happened in the economy. But that seldom happens.
© 2007 Edward Lotterman
Chanarambie Consulting, Inc.