An Antidote for Inflation: Raising Interest Rates

By Krista Swanson

With a farmer husband and four growing children, demand for food is strong in my home. When food prices rise, it immediately hits my grocery bill. You can likely relate. With food and household necessities. And on the farm.

This year the United States Consumer Price Index, a measure of inflation, reached the highest level in more than four decades. Remembering sky-high interest rates and plummeting land values, those seasoned in the agriculture industry may be wary of any situation that results in comparison to the 1980s.

Going back a decade earlier to the early 1970s, strong commodity prices and expanding trade brought about a fleeting period of farm prosperity that was accompanied by increasingly high inflation. These factors drove farm land values to rise more than 10% per year between 1970 and 1980. High net farm incomes, expectations for continued increase in land values, and low interest rates; an enticing combination for purchasing and financing farm land setting the stage for the looming bust that resulted. 

Think of inflation as a condition to be cured and one antidote is Federal Reserve action to raise interest rates. The higher cost of money reduces purchasing power. This leads to the chain reaction of less purchasing » reduced demand » and lower prices.  

Fed action to raise interest rates was the treatment of choice. With Fed action to curb inflation, interest rates rose above 20%. Although recession was a side effect of treatment, the overall economic goal was achieved. Inflation declined, and the United States enjoyed relatively low inflation from 1983 through 2020, when the inflation rate averaged 2.6%. Since 2020, things have been anything but normal. Various explanations can be given for current high inflation levels:

1. COVID and responses yielded a recessionary period in which consumer spending slowed and savings increased. Pent-up demand induced spending as economic activity resumed.
2. The pandemic caused supply chain disruptions. As global markets attempt to adjust to transformed “post-COVID” consumer demand for products and services, there are overall difficulties in meeting demand, shortages, and higher prices.
3. The Federal government instituted aid packages placing a great deal of money into the economy and directly to consumers, thereby increasing spending power and demand for products.
4. Energy prices have increased. Two reasons are governmental policies and the Ukraine-Russia war.
5. Food prices have increased because of strong global demand.
6. Higher labor costs as employers raise wages to attract workers. Labor wage inflation generally translates into higher general inflation.

Throughout 2022, the Fed has again raised interest rates multiple times in effort to combat inflation. But dire circumstances of the 1980s are not inevitable. Although modern parallels can be made to the 1980s, there are significant differences that bring relief to the farm sector.

1. Farmers are not as leveraged as in the 1970s and 1980s. In the high-income year, 1973, the national farm sector debt-to-asset ratio was 15.95%. By 1985, it grew to 22.19%. In 2012, the debt-to-asset ratio reached a low point of 11.28%. It has steadily grown since, projected at 14.11% for 2022, but remains lower than historic levels.
2. Interest rates are climbing, but remain historically low. The rate on 10-year constant maturity U.S. treasury notes is a benchmark used to evaluate interest rates over time. From a 6.2% rate in 1971, interest rates trended upward to an annual high of 13.9% in 1981. From 2017 to 2021, rates averaged 1.94%, far from the interest rate environment of the 1970s and 1980s. 
3. Crop insurance has fundamentally altered the riskiness of farm income, as intended. The modern crop insurance program did not expand to include revenue coverage until 1996. In the 1980s crop insurance was limited to a basic version of APH yield insurance, and only at low coverage levels. Modern insurance allows producers to limit losses and reliably address risks associated with crop farming. 

The challenges farmers face at the onset of the planning season for 2023 is being in the midst of the treatment – that point where you are taking the antidote, but it’s causing some side effects and the original ailment still isn’t cured. For 2023 farmers are facing the combination of higher interest rates paired with not-yet-cured inflation. As higher costs attack from all angles studying the past provides reassurance that raising interest rates can be an effective treatment. Knowing the factors that reduce risk relative to a historical comparison is helpful for staying focused, but remaining a diligent financial manager remains important at all times. 

Krista Swanson is a consultant and speaker for her business AgSCOPE, and a research analyst for the Department of Agriculture & Consumer Economics at the University of Illinois where her work is frequently published in articles on farmdoc. Krista and her husband actively farm with his family where they raise corn, soybeans, and four kids on the farm. 

Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not necessarily reflect the views, opinions or positions of FCS Financial.