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ESSAYS ON ISSUES

THE FEDERAL RESERVE BANK
OF CHICAGO

OCTOBER 1988
NUMBER 14

Chicago Fed Letter
D rought
Crop production estimates released on
September 12, 1988 by the U.S. De­
partment of Agriculture were not good
news for consumers worried about the
drought’s effects on food prices. USDA
projected 1988’s overall crop pro­
duction to be
> down 17% from last year;
> down 25% from the all-time
highs, most recently reached in 1985;
and
> comparable to the curtailed out­
put of 1983 when drought and a large
reduction in acreage pulled crop pro­
duction to a 9-year low.
Of the major crops, barley, oat, and
spring wheat production are expected
to be down about 50% from last year.
Fortunately, the decline in total wheat
production may be held to 14% as the
winter wheat crop virtually escaped
this year’s drought damage.
Corn and soybeans, the major crops of
the Seventh Federal Reserve District,
were also hard hit. Nationwide, corn
production is expected to be down 37%
from last year and soybean production
down 23%. Estimates for the five dis­
trict states point to a 43% decline in
corn production and a 27% decline for
soybeans.
The bulk of the production losses stem
from reduced per-acre yields. Corn and
soybean yields per harvested acre this
year are expected to be the lowest since
1974, down 34% and 23%, respec­
tively, from last year. In addition, the
production losses for most crops par­
tially reflect an increase in acreage
abandonment—
fields simply left unhar­
vested because of extensive drought
damage—that offset a slight rise in
planted acreage this year.

The drought affected a wide range of
other crops as well. Hay production
will likely be down 12%, despite bene­
ficial late-season rains and emergency
measures that permitted haying on
acreage originally intended to be held
out of production this year under gov­
ernment farm programs. Several fruits
and vegetables grown in the Great
Lakes region were also hit, contributing
to the estimated declines of 23% and
30% in the nation’s apple and cherry
harvests, respectively. Major Great
Lakes vegetable crops, such as peas,
sweet corn, and beans also suffered ex­
tensive losses.
Prices

Farm prices have risen sharply in re­
sponse to the drought and most ob­
servers expect a surge in food prices.
These expectations, in turn, have
added to other concerns—the tightening
labor market, high capacity-utilization
rates in manufacturing plants, and the
low value of the dollar—about a
rekindling of inflationary pressures. In­
deed, the food component of the Con­
sumer Price Index rose at an annual
rate of 10% during June and July,
substantially above the 3.5% annual
rate of increase during the first five
months of this year.

History

The table on page 2 summarizes the
trends in prices received by farmers and
in retail prices for food and for all con­
sumer items that were associated with
the major droughts occurring in 1974,
1980, and 1983. National average peracre corn and soybean yields fell
sharply in each of those years. But 1983
saw the sharpest drops, 28% for corn
and 17% for soybeans.
Farm and consumer prices varied
widely among those three periods.
Much of that variation was due to dif­
ferent underlying trends in the farm
sector and the economy.
Both the 1974 and the 1980 droughts
occurred when the economy was expe­
riencing sluggish growth and brief pe­
riods of recession. By contrast, the 1983
drought occurred in the early stages of
the present economic recovery.
The 1974 and 1980 droughts also coin­
cided with periods of double-digit inFarm share of food dollar
farm value as a fraction of retail food dollar
0.00

0.25

0.50

Retail food prices may continue to
register large gains in coming months.
But a review of food price trends asso­
ciated with recent droughts offers some
hope that the surge in food prices may
be short-lived and have only a modest
impact on overall inflation.
The way a drought affects prices and
inflation can be significantly influenced
by underlying economic factors and
trends. Recession or expansion, weak
or strong dollar, and prevailing infla­
tionary trends must be factored into the
equation.

'Average of annual data for 1984-1987.
SOURCE: USDA.

0.75

$1.00

P r ic e t r e n d s in r e c e n t d r o u g h t s
Year of drought

Year before drought

Year after drought

First 2 quarters***
1974 Drought
Background economy

(73 Q2-74 Q2)

(74 Q2-74 Q4)

Entire year
(74 Q2-75 Q2)

1st oil shock & subsequent recession; high inflation; weakening dollar; low carryover grain stocks;
growing food exports

% change in*
Farm p rice s"
CPI-food
CPI-all items

3.3
15.6
10.6

18.4
10.7
12.6

2.1
8.1
9.7

1980 Drought

(79 Q2-80 Q2)

(80 Q2-80 Q4)

(80 Q2-81 Q2)

Background economy
% change in*
Farm prices**
CPI-food
CPI-all items
1983 Drought
Background economy
% change in*
Farm p rices"
CPI-food
CPI-all items

(75 Q2-76 Q2)

4.8
4.4
6.1
(81 Q2-82 Q2)

2nd oil shock; high inflation; back-to-back recessions; dollar hits bottom; food exports peak, turn down;
normal carryover grain stocks
-8 .4
7.0
14.5

23.7
11.4
9.2

(82 Q2-83 Q2)

9.6
9.0
9.8

(83 Q2-83 Q4)

(83 Q2-84 Q2)

0.2
4.7
6.8
(84 Q2-85 Q2)

Beginning recovery; dollar strong & rising; inflation low & dropping; carryover grain stocks high; food
exports weak
-3 .9
2.2
3.3

-1 .0
0.7
4.2

5.0
3.3
4.3

- 7 .8
2.5
3.7

'A ll percent changes are based on the differences between the beginning and ending quarterly averages for the quarters indicated.
"Figures shown for the 1974 drought are based on the index of prices received by farmers for all farm products. For the 1980 and 1983 droughts, the
figures are based on the index of prices received by farmers for food commodities.
'"P e rce n t change in this column are at an annualized rate.

flation that stemmed largely from the
two energy shocks of the 1970s. In ad­
dition, price controls imposed in 1971
were winding down when the 1974
drought happened.
There was a far more modest inflation
rate in 1983 that more nearly mirrored
the 4.5% rate that held at the begin­
ning of 1988’s drought.
The strength of the dollar was different
during past dry spells, as well. That
factor had some effect on foreign de­
mand for farm commodities during
such periods of relative scarcity. The
dollar was weakening in 1974, and in
general continued to decline, hitting
bottom at about the time of the 1980
drought. At the time of the 1983
drought, the dollar was substantially
higher. In recent years, the dollar has

been declining and now approximates
the lows of 1980.
Conditions within the farm sector also
varied widely during these periods of
stress. Carryover stocks of grains and
beans had already been pulled down to
extraordinarily low levels just before
the drought-reduced 1974 harvest, re­
flecting the surge in exports when the
U.S. resumed grain sales to the Soviet
Union in mid-1972. That drawdown
on U.S. stocks helped trigger an explo­
sion in food prices even before the 1974
drought struck.
U.S. exports of grains and soybeans
continued to expand during the 1970s,
reaching a peak in the fiscal year that
ended with the 1980 drought. Despite
this expansion, carryover stocks had
been rebuilt to more traditional levels
when the 1980 drought hit.

Exports weakened in the early 1980s
(as the dollar strengthened) and
carryover stocks became more burden­
some. But it was those “burdensome”
grain and soybean stocks that helped
to minimize the supply disruptions that
followed the sharp downturn in the
1983 crop harvest.
As a buffer against the 1988 drought,
carryover stocks of grain are
large—roughly comparable to those of
1983. Soybean stocks, however, are
tighter, and more comparable to con­
ditions in 1974.
Parallels

While trends in farm and consumer
prices were different in each of the
three recent droughts, some interesting
tendencies are evident in the accompa­
nying table. For example, trends in re-

tail food prices more closely parallel the
overall inflation rate than the more
volatile farm price index.
Further, in each episode, the rise in re­
tail food prices four quarters after the
onset of the drought was less than the
rise in the overall CPI. And, in each
case, retail food price rises moderated
in the year after the drought.
The table shows that a major drought
can lead to an acceleration in the rate
of retail food price increases over a
quarter or two, such as occurred in
1980. But several factors can dampen
that rise, limit the time over which it
occurs, and ease the effects of such in­
creases on the overall inflation rate.
With respect to the effect on inflation,
food prices account for only 16% of the
overall consumer price index. Hence,
all else equal, a 10% rise in retail food
prices would translate into a 1.6% rise
in all consumer prices.
With respect to drought effects on retail
food prices, several factors tend to
dampen the pressures. First, the food
industry is fairly competitive. This
tends to guard against indiscriminate
price increases when a major drought
leads to perceived food shortages.
A second dampening factor relates to
the comparatively minor share of retail
food expenditures that is represented
by the farm value of raw food com­
modities. In recent years, the farm
value of domestically produced raw
food commodities has been equivalent
to about 26 percent of all consumer
food expenditures, including expendi­
tures on imported foods and for foods
in food-service establishments. In terms
of a market basket of domestically
produced foods bought in grocery
stores, the farm value component aver­
aged only slightly higher, 31 percent
(see figure on page 1). The remaining
share encompasses the assorted costs of
processing, shipping, packaging, and
retailing food beyond the farm gate;
costs which tend to rise more in line
with the overall inflation rate.
Moreover, for foods that tend to have
the biggest supply cuts in a drought,
such as cereals and bakery products,
oilseeds, fruits, and vegetables, the farm

value component is even less than the
average for all foods.
Thus, as long as food processing and
distribution costs are held in line, a
surge in the farm cost of food should
translate into a much smaller rise at
retail.

because of the differences in life cycle,
breeding practices, and feeding alter­
natives for cattle.
But, with the beef cow inventory at its
lowest level in over 20 years, any bulge
in cattle marketings from this year’s
drought will likely be shorter than
normal.

Response

The production response of farmers to
drought may also hold down the size
and duration of food price increases.
As has been the case this year, the
prices of crops most directly affected by
the drought rise sharply with the
drought’s onset and remain high for
months. These higher prices, in effect,
ration the consumption of the crops
and thus lessen the possibility of short­
ages. At the same time, they encourage
expanded plantings for the next pro­
duction cycle, both in the U.S. and
elsewhere in the world.
Domestically, the crop production re­
sponse to a drought is about a year for
most field crops, but can be as short as
a few weeks for some vegetables that
have short growing seasons and multi­
ple harvests within a year. In 1989, the
domestic crop production response will
be enhanced considerably because gov­
ernment price support programs will
be altered to permit a large portion of
the 54 million acres of cropland held
out of production this year to be
planted next year. On a world-wide
basis, the crop production response can
be shortened to about 6 months be­
cause of different planting and harvest­
ing schedules in the Southern
Hemisphere.
The production response of livestock
farmers can also ease the pressure on
retail food prices, at least in the short
run. A drought-induced surge in feed
costs forces some livestock and poultry
producers to scale back their oper­
ations. This scaling back can lead to
temporarily increased supplies and
lower retail prices for meat.
For poultry producers, this period of
increase is fairly short. With hogs, the
period is longer. For cattle the period
of increased supplies can be consider­
ably longer and the drought-related
bulge in supplies more pronounced,

Outlook

It seems probable that the rise in retail
food prices will accelerate, but
projections of the magnitude of the rise
vary. Top USD A officials have
projected an average annual rise of 3%
to 5% for retail food prices this year
(versus 4% last year) and 5% to 7% for
next year. Other analysts have
projected increases of up to 9% for
1989.
But, assuming that the overall inflation
rate holds fairly stable—thus holding
the line on processing and distribution
costs—there is hope that retail food
price rises may be at the lower range
of recent projections.
— Gary L. Benjamin

i •

v ., .

K arl A. Scheld, S enior Vice President and
D irector o f R esearch; D avid R. A llardice, V ice
President and Assistant D irector o f R esearch;
E dw ard G . N ash, E ditor.
C hicago Fed L ette r is published m onthly by the
R esearch D ep artm en t o f the F ederal Reserve
Bank o f C hicago. T h e views expressed are the
au th o rs’ and are n o t necessarily those o f the
F ederal R eserve Bank o f C hicago o r th e F ederal
R eserve System . A rticles m ay be rep rin ted if the
source is credited and the R esearch D ep artm en t
is provided w ith copies o f the reprints.
C hicago Fed L ette r is available w ith o u t charge
from the Public Inform ation C en ter, F ederal
Reserve Bank o f C hicago, P .O . Box 834, Chicago,
Illinois 60690, o r telephone (312) 322-5111.

ISSN 0895-0164

Industrial production in the nation grew at its second lowest rate of the year in
June, according to the Federal Reserve Board. Flatness in auto assemblies, which
have been a major source of strength all year, accounted for much of the slow­
down. Industries supplying the auto industry, such as primary metals, also ex­
perienced some slowing. Nondurables continued to be weak relative to durables.
Midwest Manufacturing activity jumped by 1.5 percent in June. This was the
largest increase in the MMI of the year. Transportation equipment continued its
strong performance with a 2.2 percent rise. Food processing and chemicals each
rebounded from a sluggish May with increases of 2.7 percent and 2.2 percent,
respectively.

Chicago Fed Letter
n r r iia ir v

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FE D E R A L R E SE R V E B A N K O F C H IC A G O
P u b lic In fo rm a tio n C en ter
P .O . B o x 834
C h ic ag o , Illin o is

60690

(312 )3 2 2 -5 1 1 1

04
3201
CHI
ARCHIVES
RECORDS MANAGEHENT

N O T E : T h e M M I is a com posite index o f 17
m anufacturing industries a n d is constru cted from
a weighted com bination o f m onthly h o u rs worked
an d kilow att hours d a ta . See “ M idw est M a n u ­
facturing Index: T h e C hicago F ed ’s new regional
econom ic in d icato r,” Economic Perspectives, F ederal
Reserve Bank o f C hicago, V ol. X I , N o. 5,
S ep tem b er/O cto b er, 1987. T h e U n ited S tates
represents th e F ederal Reserve B oard ’s In d ex o f
In d u strial P roduction, M anu factu rin g .


Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102