A sustained 50 and 100 basis point increase in the 90 day Treasury Bill interest translates into mortgage rate hikes of 43 and 87 basis points, respectively, by the year 2002. Agricultural impacts accrue through marginal intermediate run reductions in commodity prices, a reduced rate of inflation, and, of course, higher interest rates.

A majority of the 76 farms and ranches analyzed experience reduced net cash farm income in the range of 1 to 4 percent under the 50 and 100 basis point scenarios. Of course, farms already drawing on cash reserves or refinancing operating debt under the Baseline are more adversely affected by increased interest rates.

This report responds to a FAPRI/AFPC request by Senator Harkin to examine the economic impacts of increased interest rates on U.S. agriculture. AFPC estimated the macro economic impacts which were used by the Food and Agricultural Policy Research Institute (FAPRI) to project the agricultural sector level impacts on commodity demand, input price inflation and commodity prices. The changes in input and commodity prices were used in the representative farm analysis. FAPRI's assumptions and analysis are reported under a separate cover titled "Interest Rate Effects on The United States Agricultural Sector - FAPRI Working Paper # 02-97."

This report is organized into three sections. The first section describes the assumptions and macro economic impacts on the general economy from a sustained 50 and 100 basis point increase in 90 day Treasury Bill rate for 1997-2002. The second section provides a discussion of FAPRI's estimated impacts on intermediate and long-term interest rates, inflation, land prices and commodity prices for the baseline and higher interest rate scenarios. The final section summarizes the results of the increased interest rates on 76 representative U.S. crop and livestock farms.

The macro and farm level impacts of the 50 and 100 basis point increase in the 90 day Treasury Bill rate is compared to the FAPRI/AFPC Baseline reported in AFPC Working Paper 97-1 titled "Representative Farms Economic Outlook: FAPRI/AFPC January 1997 Baseline." AFPC Working Paper 97-1 also provides a detailed description of the representative farms used in this report.

The effects of a tighter monetary policy designed to address the prospects of future inflation were simulated by increasing the 90 day Treasury Bill rate over baseline levels. Two monetary policy actions were examined: (1) actions leading to a 50 basis point increase in the 90 day Treasury Bill rate and (2) actions leading to a 100 basis point increase. It was assumed that these actions were initiated at the beginning of 1997 and were maintained through 2002.

The impact of these actions on the general economy is registered in different markets. In the nation's money markets, we would see an increase in bond yields and mortgage interest rates reflecting both a higher cost of short-term funds and a growth in federal budget deficits over the longer run. The NIPA federal budget deficit would be some $33 billion higher than baseline levels by 2002 if short-term interest rates were increased by 50 basis points and nearly $68 billion higher if short-term rates were increased by 100 basis points. Mortgage rates would eventually climb by 43 basis points and 87 basis points above baseline levels by the end of 2002 under these two scenarios, respectively. Corporate bond rates would fully reflect the higher cost of short-term funds by that time (Figure 1).

Economic activity in the nation's product markets would reflect the slowdown in real GDP caused by lower levels of capital formation as well as a stronger U.S. dollar which exacerbates the U.S. negative trade balance. The slow down in capital formation reflects both the higher cost of longer-term loanable funds in the nation's money markets as well as the decline in pre-tax business profits resulting from reduced sales activity and higher debt servicing costs. The overall price level as measured by the price deflator for GDP does, however, reflect the desired effects the Federal Reserve is looking for with respect to inflationary trends (Figure 1).

The nation's labor force would experience increased unemployment, peaking at the end of the decade and then improving as the economy begins to approach baseline growth levels. The additional slack created in labor markets by the tighter monetary policies assumed in this study reduces inflationary wage pressures.

Thus, the imposition of a tighter monetary policy accomplishes its objective of reducing future inflationary pressures by increasing the cost of loanable funds, slowing the growth in aggregate demand, and creating some slack in labor markets. The magnitude of these effects is slight in light of : (a) the relatively small adjustments to short-term rates assumed in this study, (b) the stagnant nature of the world economy, and (c) the continued resiliency of the domestic general economy. Those most affected by the monetary policy actions assumed in this study are households who experience unemployment by these actions and businesses who are highly leveraged and thus see their debt service costs increase disproportionately.

FAPRI projects modest changes in crop, livestock and dairy prices due to the two interest rate scenarios (Tables 1 and 2). Wheat and feed grain prices deviate between +/- 1 cent/bu from the Baseline, cotton +/- 2 points/lb., rice +/- 1 cent/cwt. and soybean meal +/- $1/ton (Table 1). Cattle prices are down less than $1/cwt. through 2000 before showing slight increases in 2001-2002. A similar price pattern is projected for hogs and milk (Table 2).

Inflationary impacts on specific input items such as seed, fertilizer, chemicals, fuel and labor are reported in Table 3. As with commodity prices the impacts of the interest rate increase on these input items are marginal as sector level demand diminishes.

The projected rate of change in land values is dampened under both interest rate scenarios relative to the Baseline. For the 50 basis point scenario the rate of change is down 32 points on average from 1998 to 2002. Under the 100 basis point scenario the rate falls 77 points by 1999 and is still 47 points lower in 2002 (Figure 1).

The 76 representative farms maintained by AFPC are diverse geographically, by commodity type and economically. They range from slightly under $100,000 in annual gross revenue for the 300 cow ranch in North Central Wyoming (WYB300) to over $35,000,000 for the large scale 13,000 sow hog farm in Eastern North Carolina (NCH13268). The farms are located in the major U.S. production areas as illustrated in Figure 2. A brief description of each operation is included in Appendix A.

All crop farms are assumed to begin 1996 with 20 percent intermediate and long-term debt, based on information provided by ERS-USDA and the representative panel farm members. Beginning debt levels for the hog farms are assumed at 45 percent, the dairy farms at 30 percent and the cattle ranches at 1 percent for land and 5 percent for machinery.

Average net cash farm income is the performance variable chosen for demonstrating the farm level effects of changing the 90 day Treasury Bill rate. Net cash farm income equals gross receipts minus all cash production costs including interest payments. Net cash farm income is used to pay family living expenses, principal payments, income taxes, self employment taxes, and capital replacement costs. The values in Figures 3-6 represent the average percentage change in net cash farm income for the 1997-2002 study period. Individual year results over the 1997-2002 study period are included in Appendix B.

Feed Grain Farms - All 13 feed grain operations experience declines in net cash farm income as interest rates increase. The decline, however, is no more than 3.5 percent for nine of the thirteen farms under the 100 basis point scenario (Figure 3). The remaining four farms include the moderate Northern Missouri operation, the moderate irrigated farm in Nebraska and both irrigated operations in Kansas. Net cash farm incomes on these four farms decline from 5 percent for the large Kansas farm (KSG1652) to over 10 percent for the moderate Kansas operation (KSG728), under the 100 basis point scenario. All four of these farms were either drawing down cash reserves and/or refinancing operating debt under the Baseline. Increasing interest rates compounds the pressure on net cash farm incomes as debts rise.

Wheat Farms - All 10 wheat farms experience declines in net cash farm incomes as interest rates increase. Only the moderate size Kansas farm experiences a decline in excess of 4 percent. Under the 50 basis point scenario the moderate Kansas farm's net cash farm income falls by approximately 5 percent. Under the 100 basis point scenario the decline would be approximately 9 percent. The KSSC1495 farm was the only wheat farm under the January 1997 Baseline to draw down or refinance operating debt throughout the 1997-2002 study period.

Cotton Farm - All 10 cotton farms experience a decline in net cash farm incomes as interest rates increase. Only three farms' net cash farm incomes decline in excess of 4 percent under the 100 basis point scenario (Figure 4). These three farms include the moderate scale operations in the Texas Blacklands (TXBL1200), Texas Coastal Bend (TXCB1700), and Mississippi (MSC1635). All three farms were drawing on cash reserves and/or refinancing operating debt under the January 1997 Baseline.

Rice Farm - All eight rice farms experience a decline in net cash farm income as interest rates are increased. The two Missouri operations appear the most vulnerable (Figure 4). The moderate Missouri farm (MOR1900) has an 11 percent reduction in net cash farm income under the 100 basis point scenario while its large scale counterpart loses 5.5 percent (MOR4000). The moderate Missouri farm was refinancing operating debt as early as 1998 under the Baseline while the large Missouri operation started drawing on cash reserves in 1999.

Cow/Calf Ranch - All five cattle ranches experience declines in net cash farm income with increasing interest rates (Figure 5). The Wyoming and Texas operations appear the most sensitive as both were having to refinance operating debt every year under the Baseline. The increase in interest rates compounds the debt pressure already building on these two ranches.

Hog Farm - Seven of the eight hog farms experience a decline in net cash farm income as interest rates increase (Figure 5). The Indiana moderate size operation (INH150) is the most sensitive. This farm experiences declines of approximately 8 percent under the 100 basis point scenario. Like the crop farms, the Indiana operation was refinancing operating debt even under the Baseline.

The large scale North Carolina (NCH13268) operation actually shows a slight increase in net cash farm income as interest rates increase. This farm was highly profitable under the Baseline and as such accumulated significant ending cash reserves throughout the study period. In addition the large North Carolina farm is a contracting operation and therefore does not carry substantial assets or debt. Thus the increase in interest costs are more than offset by reduced input cost and additional earned interest on cash reserves.

Dairy Farm - The impact of increasing interest rates on the 22 dairy farms is mixed. Fifteen of the dairy farms experience modest declines in net cash farm income as interest rates increase, while seven increase net cash farm income. Dairies in Washington, California, New Mexico, Texas, Wisconsin, and Missouri are more likely (6 of 12) to see increases in net cash farm income than those in New York, Vermont, Georgia, and Florida (1 of 10). Like the large North Carolina hog farm, dairies showing increases in net cash farm income under both scenarios were among the most profitable under the Baseline. Lower inflationary impacts on purchased inputs and additional interest earnings on cash reserves more than offset increased interest expenses.

In percentage terms the moderate Georgia operation (GAND175) is the most vulnerable; experiencing a decline in net cash farm income of 182 percent (Figure 6). This is somewhat misleading because the average net cash farm income over the 1997-2002 study period was only $870, therefore, a $1583 decline in net cash farm income results in the large percentage difference.

A majority of the 76 farms and ranches analyzed experience reduced net cash farm income in the range of 1 to 4 percent under the 50 and 100 basis point scenarios. Of course, farms already drawing on cash reserves or refinancing operating debt under the Baseline are more adversely affected.

APPENDIX B:

DETAILED FARM LEVEL
IMPACTS ON NET CASH FARM INCOME

Appendix Tables B1 - B8