Farmers, Interest Rates and Reality

July 5, 2000

Usually when opportunity knocks, the sky is the limit. But just how high is the sky when Federal Reserve Board Chairman Alan Greenspan raises interest rates? And how hard will the thud felt by farmers and ranchers be when our entire economy is brought back down to earth? Those issues are addressed in an article by John Skorburg, American Farm Bureau Federation senior economist and trade specialist.

The last recession suffered by the U.S. economy was in 1991, when the gross domestic product (GDP) contracted 0.6%. This 1991 recession was preceded by GDP inflation of 4.4% per year for both 1989 and 1990.

With U.S. farmers and ranchers facing a debt load three times their net cash income, rising interest rates will hit farmers even harder as they attempt to renew loans over the next year, writes Skorburg. Subsequent to those years, the Federal Reserve increased the federal discount rate charged to member banks for borrowed funds from a low of 5.5% in 1987 to a high of 7% in 1990.

At present, the Fed has increased this same rate from 4.5% last year to 6% today, Skorburg says. The Federal Reserve typically uses higher rates as a tool to combat inflation. But in the case of agriculture prices, many are just coming off of 20-year lows. This is known as "deflation," or lower prices. To use monetary policy to slow inflation in the ag sector is a case of fighting the wrong battle, Skorburg asserts. Of course, Fed policy makers pay attention to any number of rising costs – such as wages – that are essentially unrelated to whether farm prices are rising or falling.

For most borrowers, interest rates on purchases made on credit are approaching double-digit rates not seen since the early 1990s. In fact, following the mid-May Federal Reserve rate hike, several banks immediately increased their prime rate for their best customers to 9.5%. "This will likely push many (farmers) operating loans to well above 10%," noted American Farm Bureau Federation President Bob Stallman.

If the Federal Reserve continues to raise short-term interest rates, this will only squeeze capital-intensive businesses such as farming and ranching even more. The decision to raise short-term rates eventually will slow the economy, but it will place additional pressure on those sectors already experiencing deflation, such as agriculture. The only short-term hope for agriculture is for expanded markets. This is why Farm Bureau has been so focused on expanding trade with China and easing food and medicine sanctions against Cuba and other countries, he adds.

When this temporary "oil-shock" inflation passes through the system, core inflation rates should again subside to very benign levels, Skorburg believes. Farm Bureau hopes that the Federal Reserve will finally see that overall inflation is not the long-term problem it perceives and that healthy productivity can allow the economy to grow faster without creating heightened inflation.

Based on a recent report from the Organization for Economic Cooperation and Development (OECD), the U.S. economy--due to increased productivity--can grow faster without generating additional inflation. According to the OECD study, the expansion of potential output has risen to 3.6% per year from 2.5% in the early 1990s.

In short, the U.S. economy can now grow by almost 4% per year without igniting inflationary forces. For the sake of agriculture it's time that the Federal Reserve recognizes this important economic change, says Skorburg.

Skorburg’s entire article is on the AFBF’s web site at http://www.fb.com.