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Abstract
The agricultural commodity crisis of 2006-8 and the recent evolution of
commodity markets have reignited anxieties in Finland over fast-rising food
prices and food security. Although the impact of farm commodity price shocks on
the final consumer is mitigated by a large degree of processing as well as the
complex structure of the food chain, little is known about the strength of the
linkages between food markets and input markets. Using monthly series of price
indices from 1995 to 2010, we estimate a vector error-correction (VEC) model in
a co-integration framework in order to investigate the short-term and long-term
dynamics of food price formation. The results indicate that a statistically
significant long-run equilibrium relationship exists between the prices of food and
those of the main variable inputs consumed by the food chain, namely
agricultural commodities, labour, and energy. When judged by the magnitude of
long-run pass-through rates, farm prices represent the main determinant of food
prices, followed by wages in food retail and the price of energy. However, highly
volatile energy prices are also important in explaining food price variability. The
parsimonious VEC model suggests that the dynamics of food price formation is
dominated by a relatively quick process of adjustment to the long-run
equilibrium, the half life of the transitional dynamics being six to eight months
following a shock.