3  According to the Food Outlook from the Food and Agricultural Organization of the United Nations (FAO), 22 May 2008. BIS Review 68/2008  3  When we decide on the future direction of monetary policy, it is important to know whether the rising oil and food prices will have lasting or temporary effects on inflation. 4 It is difficult to know this in advance. We must follow developments closely. But we can receive some guidance by looking at the factors that lie behind the price increases. Increased demand, supply effects and portfolio investment behind rising commodity prices One reason for the high commodity prices is the increased demand in the world market from emerging economies. Higher incomes per capita in China, India and other rapidly growing economies have led to increased demand for food and also to changes in the patterns of food consumption. Demand for meat has increased in particular, which has in turn pushed up the demand for and prices of feed grain. This also spreads to other food crops. It is reasonable to believe that the demand for food in the world will remain high. Another important driving force behind the world demand for commodities is the investment in ethanol and biodiesel in recent years. The increased use of some food commodities in the production of biofuels limits the supply of food and increases the price of food crops.
When the oil price reaches record high levels it creates a further incentive to increase the production of biofuels at the cost of food. The IMF observes in its most recent report that biofuels account for only 1.5 per cent of the supply of liquid energy. But the use of these fuels led to demand for crops used in their production doubling between 2006 and 2007. 5 In the slightly longer term the high food prices lead to the supply of food increasing and this dampens prices. But there are also factors that could hold back supply and mean that it does not increase as much as would be necessary to meet the increased world demand. Some supply shocks are of a temporary nature, such as the drought in Australia last year and poor harvests in some regions. One cannot rule out the possibility that climate effects have played a role, and in this case such shocks may be a recurring problem. 6 Another factor that has had a restraining effect on supply and has thereby contributed to boosting the increase in world food prices is the export restrictions introduced by some countries that are major producers of food, in an attempt to protect their domestic consumption from the price increases. The effect on the price of wheat when export restrictions were reduced in the Ukraine is, as I mentioned earlier, a good example of how this can have tangible effect on prices. Another factor that has certainly been significant is the depreciation of the dollar.