Agricultural drought and food inflation: evidence on the role of monetary policy

Abstract While the impact of extreme weather events on food prices has been widely documented, much less is known about the effects of milder but more frequent weather disturbances—such as water shortages, or vegetation stress—that compromise agricultural production and can silently but persistently drive food inflation. Despite their cumulative relevance, there is still no comprehensive assessment of how such recurrent shocks and food price inflation interact with monetary policy, an essential instrument to preserve price stability. This study addresses this gap by examining how central banks respond to weather-induced food inflationary pressures, with a particular focus on low-income countries where food represents a large share of household expenditure. To this end, the interconnectedness between weather shocks, macroeconomic variables, and monetary policy is explored through a Panel Vector Autoregressive model estimated on quarterly data for 107 countries from 2000Q1 to 2019Q4, and separately for high- middle- and low-income economies. We introduce the Agricultural Stress Index, a satellite-based measure of agricultural land under water stress, as a novel proxy for less abrupt but more frequent weather disruptions. Results show that food prices are highly sensitive to such shocks, with stronger and more persistent effects in low-income countries. Moreover, central banks in these economies tend to lower policy rates, an expansionary response that may inadvertently amplify food inflationary pressures. These findings highlight the importance of prompt monetary policy responses to contrast the inflationary consequences of recurrent water stress.