Agriculture and inflation: Expected and unexpected shocks

Abstract

This study assesses the inflationary role of agriculture in Brazil using procedures that measure these effects as unanticipated shocks. We focus on the effects of unexpected price shocks to three groups of commodities of the sector, understood as supply shocks, on the unanticipated changes in the IPCA, Brazil's official inflation index. Supply-side shocks related to the energy sector, the exchange rate and the international agricultural commodity prices are also considered. The theoretical basis is the hybrid New Keynesian Phillips Curve and the econometric procedures applied to the quarterly data from 2001 to 2019 are related to the analysis of autoregressive vectors – Impulse Response Functions (IRF), Forecast Error Variance Decomposition (FEVD), and Historical Decomposition of Forecast Errors (HDFE). We use two specifications: one that assumes that changes in domestic prices implicitly reflect the effects of both international dollar prices and exchange rate shocks and other which explicitly includes these two variables together with an aggregate agricultural price. The benefit of using of the two specifications is twofold: test the robustness of analytical context and examine the external components of the Brazilian inflation. The main results are: i) expected inflation, grains and diesel prices and the exchange rate stand out in explaining the variability of IPCA forecasting errors, and shocks in the IPCA itself are also relevant; ii) although of relevant magnitude, shocks to IPCA itself dissipate quickly, while supply shocks, because they are relatively large, even with small coefficients in IRF, have important impacts on inflation; iii) shocks to international prices and exchange rate affect domestic aggregate agricultural price; and iv) unanticipated supply shocks (from agriculture, energy, and exchange rate) plus inflation expectation jointly played a disinflationary role in 2018 and 2019.