November 7, 2022

Inflation, recession and the farmer

Topic: Issues

The Federal Open Market Committee of the Federal Reserve Bank (often called “the Fed”) once again raised the rate at which the Fed lends to other banks, this time by 0.75% to about 3.75%, and indicated an intent to continue raising rates at future meetings. This has been a rapid run-up from near 0% in February.

The Fed’s purpose in raising rates is to slow down the economy until prices stop rising.

They may slow down the economy, but they won’t reduce inflation any time soon, if history is any lesson.

Inflation

More than 40 years ago, respected economist Paul Volcker took over as Chair of the Fed and raised interest rates to control inflation. This slowed demand and led to a couple of painful recessions, but that was not Dr. Volcker’s purpose. He was explicitly reining in the money supply, which had grown too fast under his predecessors, and at that time his only tool to do this was raising the Fed’s interest rate. For decades afterward, the Fed kept to a policy of stable growth in the money supply, leading to low inflation, low interest rates, and strong growth in the U.S. economy. Financial markets developed a faith that the Fed would keep inflation under control. This faith gave the Fed additional flexibility to provide modest stimulus in the form of a burst of extra money in the economy when demand lagged; markets had faith that the extra money would not cause inflation, and the Fed rewarded that faith by returning the money supply to the long-term trend.

Recession

Instead, Chairman Jerome Powell keeps raising rates, choking the economy to achieve inflation goals using the modern theory that he can balance supply and demand in the economy and, so, control inflation. Applying this theory will require substantial additional increases in the interest rate, given the robust demand reflected in the still exceptionally large number of job openings in the U.S.

Modern Monetary Theory and Chairman Powell will be inextricably linked to this recession; and we have little prospect of above-target inflation ending before 2024.

The Farmer

So how does all this affect farmers?

First, short- and long-term interest rates are high and rising. In recent years, interest expense has been about 5% of farm cash production expenses. Farmers will be facing interest rates double and triple what they were just a few years ago, with corresponding increases in interest expense; high interest rates, caused by both high inflation and the Fed’s steps to address inflation, led to the farm debt crisis in the 1980s. A doubling or tripling of interest expenses now could cause similar pressures, especially for any farmer already committed to new investments, beginning farmers or farmers forced to borrow for succession. If history is a guide, it could take years for long-term interest rates to come back down to where they were for the last decade. (For additional discussion, see this report from the University of Illinois Farm Doc program.)

Second, higher interest rates tend to lower property values, including farmland values, which would make worse the debt trap of higher interest rates and lower farm returns.

Third, rising interest rates will raise the cost of all debt, including government debt, which will ultimately cost the taxpayer and limit the government’s flexibility to provide assistance in a debt crisis.

Fourth, inflation is slashing the purchasing power of American consumers, and weakening the economy, which both undercut demand for farm products and lowers prices.

Fifth, inflation undermines the real value of USDA programs, including the value of reference prices and budgets for most commodity programs.

Sixth, the aggressive interest rate increases by the Fed are making the dollar attractive to foreign investors and strengthening the dollar, which undermines U.S. agricultural export competitiveness.

Seventh, a Fed-driven recession in the U.S. is bad for the global economy, which will also undermine U.S. agricultural exports.

Farmers have a lot at stake in the actions of the Federal Reserve Bank, just as they did 40 years ago.

Go here to read the full Market Intel article.