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CAUSES OF THE CRISIS 53


food prices. First, there is no consistent evidence to date that speculation has contributed to the crisis, and what evidence there is does not show that it was a primary cause of the crisis. Second, we have omitted stocks from the main model. As with speculation, we find it very difficult to view stock declines as a primary cause of the crisis rather than merely a symptom of rising demand (for maize and soybeans) and weak production (of wheat). Instead the dominant factors consist of a set of interlinked cross-commodity factors—a weakening U.S. dollar, rising oil prices, and the consequent surge in biofuel demand—as well as two or three commodity-specific explanations. In general the complexity of this model supports the description advanced by the director of the World Food Programme (WFP) that the current crisis constitutes a perfect storm.


Finally, it is worth emphasizing the dynamic processes that have led to this crisis. In general, economists point to the efficacy of markets in smooth- ing out price volatility. Increasing demand should lead to increasing prices, which should result in a supply response, which should then lead to lower prices. Conversely, decreasing supply should lead to higher prices, which should prompt consumers to switch to substitutes. The remarkable surge in prices in 2007 and 2008 begs the question of why markets were not self- correcting, or more specifically, why they did not self-correct until mid-2008. Our review points to some interesting explanations of why prices kept rising before eventually being checked by external events (the global financial crisis) and the inherently unsustainable nature of the price bubble. We par- ticularly emphasize why the markets did not self-correct. That is, why did not demand decrease more and supply increase more as prices started to rise? Several factors explain this anomaly. On the supply side, production is seasonal and may only respond to price rises with some lag. Bad luck was also an issue, with 2006–07 witnessing some weather shocks, which in turn contributed to export restrictions, which rippled across other markets as con- suming nations switched to less restricted markets. On the demand side, the biofuels sector sustained maize demand because of ongoing high oil prices. Strong economic growth and large foreign reserves also made importing nations less sensitive to the initial price rises. In addition, in some instances importing countries seemed to panic. The peculiar nature of the rice market made precautionary purchases and hoarding a high priority for households, producers, and traders. For these reasons high prices were not immediately countered by reduced demand or increased supply, with both market and government failures contributing to these outcomes.


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