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The following are some common questions about macroeconomics and agriculture:

What implications does a change in world income growth have for agriculture?

Income growth outside of the United States is the single most important factor driving U.S. agricultural exports. As income grows, consumers will devote a share of that increased income to extra food expenditures. Changes in consumer income from either accelerating growth or the movement into recession lead to changes in the demand for agricultural goods and consequently affect the demand for agricultural imports. When incomes drop during a global recession, this causes greater unemployment and a general erosion of demand, including demand for agricultural products. Since trade makes up the difference between production and consumption, this often translates into reductions in import demand that are proportionately greater than the decrease in domestic demand.

The degree to which changes in income growth affect agricultural import demand depends a lot on which countries are affected. Japan and high-income countries in Europe have very low income elasticities of demand for agricultural products (on the order of 0.1 or less), and respond weakly to changes in income. On the other hand, middle- and low-income countries such as China and India have relatively high income elasticities of demand (on the order of 0.25 to 0.5), which implies much larger impacts on agricultural trade associated with changing incomes. Given the higher income elasticities, high economic growth rates in middle- and low-income countries can have a larger impact on U.S. agricultural exports than a corresponding economic growth in high-income countries. For instance, changes in Japanese economic growth will have very little impact on U.S. exports to Japan. Beginning in the 1990s, when Japan experienced very slow growth and recession, the real (adjusted for inflation) value of U.S. agricultural exports to Japan remained relatively constant.

Falling incomes and wealth reduce consumer demand for foodstuffs, but the effect may be more severe on demand for other traded goods because consumers will reduce their expenditures for nonfood items more readily than those for food. The degree to which demand drops for specific foodstuffs depends on income elasticities of demand. Demand for high-value foodstuffs such as livestock products and fruit is relatively income elastic, while demand for staple foods such as bread and potatoes is income inelastic. In poorer countries, the income drop might increase the demand for staples (inferior goods). The general fall in domestic demand usually results in a strengthening of a country's agricultural trade balance by either reducing imports or increasing exports.

Why are exchange rates important for agriculture?

The exchange rate is the price at which one currency converts to another. Currency depreciations and appreciations change the value of currencies against the U.S. dollar. If the currency of a U.S. trading partner depreciates against the dollar, that makes U.S. exports to that country more expensive in local currency terms. The reduced exchange rate raises consumer and producer prices for imported foodstuffs, as well as prices for tradable agricultural inputs, expressed in the country's currency.

An exchange rate change also changes prices of domestic foodstuffs. The degree to which domestic prices change from an exchange rate shock depends on the transmission elasticity (or exchange rate pass-through). Transmission elasticities vary by country, and also within countries among commodities.

The increase in domestic consumer prices in a country that depreciates against the U.S. dollar reduces food import demand from the United States. When the Malaysian ringgit depreciated approximately 50 percent during the Asian financial crisis in 1997, for example, the cost of U.S. soybeans in Malaysia doubled overnight. This reduced the demand for imported soybeans and increased the demand for domestic animal-feed substitutes. The net effect was that Malaysia imported fewer U.S. soybeans and increased production of domestic feeds. This reduction in demand also had the effect of reducing the price of soybeans in U.S. dollar terms.

A currency depreciation changes agricultural producers' terms of trade. If the terms of trade improve (output prices rising more than input prices), producers are motivated to increase output. If terms of trade worsen, production falls. The depreciation of the Argentine peso in the first few months of 2002 provides a good example of what happens after a major exchange-rate change. Argentina is a significant agricultural exporter, so the more than 50 percent depreciation in early 2002 resulted in higher domestic prices for export crops such as wheat, soybeans, and corn.

However, a significant component of Argentina's agricultural inputs, such as fertilizer, are imported, resulting in higher costs to farmers. At the same time, the government instituted export taxes, which reduced the benefit of increased domestic prices for agricultural commodities. Furthermore, the disruption of the economy from the economic crisis likely precluded significant increases in agricultural production and exports. The net effect-as presented in USDA's 2003 Baseline Projections-was a decline in Argentinean wheat and corn production in 2002/03 because of high input prices and record high production of soybeans.

In most cases of currency devaluation, the domestic agricultural terms of trade improve for the devaluing country. The primary inputs of labor and land are essentially nontradable, and farmers in some countries rely largely on domestic inputs, so prices to producers do not necessarily increase as a result of currency depreciation. Rising production from an upswing in producers' terms of trade and falling demand for imported agricultural goods improves a country's balance of agricultural trade. (For specific goods, either imports fall or exports rise, depending on whether the country is a net importer or exporter).

However, for some agricultural producers in some countries, currency depreciation can worsen terms of trade, causing a decline in output. This occurs if a large share of inputs (in value terms) is imported and prices for such inputs rise more than prices for outputs. These conditions tend to hold more for producers of high-value and processed goods, such as poultry farmers who import their feed, rather than producers of bulk commodities. For such high-value commodities, the effect of currency devaluation on the trade balance is uncertain. If the drop in consumption from higher domestic consumer prices is greater (smaller) than the fall in production, the trade balance improves (worsens).

How important is the farm economy for the rural economy and the rural economy for the farm economy? How important is the macroeconomy for both of these sectors?

During the Depression of the 1930s, the rural and farm economies in the United States were largely synonymous, as those rural residents not working on a farm either provided direct support services to those on the farm or ranch or worked for businesses that provided services to the farm sector. The current rural economy is far more complicated. Farming now ranks behind manufacturing, construction, retail trade, health services, and Government as source of rural jobs (based on data from the U.S. Department of Commerce, Bureau of Economic Analysis). In terms of economic dependence, farming is second only to manufacturing as the dominant activity in industry-dependent counties.

Farming now accounts for less than 1 percent of the U.S. gross domestic product, but has economic significance beyond the farm gate. While the manufacturing of farm machinery and fertilizer is mostly done in metro counties, farm services and food processing are disproportionately located in non-metro counties. Even in many counties that are dependent on manufacturing or services, farming can be an important component of local communities.

Many farm households depend on off-farm income to survive. The rural economy is the source of many off-farm jobs, from manufacturing to services. Even the largest farms have significant off-farm income. Without the large number of manufacturing and service jobs available in rural areas, many households would be much less likely to farm.

The farming and rural manufacturing industries are tightly tied to the world economy. Any sustained period of slow world growth or a very strong U.S. dollar hurts both farm and manufactured goods exports. The world oil and capital markets have large impacts on both of these raw material and capital-intensive industries. So, when world conditions are prosperous, farm households have both relatively high commodity prices and good off-farm job prospects.

How does the Federal Reserve Board influence interest rates through monetary policy?

Interest rates are a major target of monetary policy. When the Federal Reserve Board wants to constrain growth under situations when actual gross domestic product (GDP) exceeds potential GDP and thus lower the risk of inflation, it raises the federal funds rate on overnight bank borrowing. The increase in the federal funds rate will generally be followed by increases in a broad range of interest rates in the economy. The general implication of increased interest rates is to lower overall borrowing, which reduces the overall demand for goods and services. This lowers the pressures for increasing inflation. When the Federal Reserve wants to stimulate economic activity during times of slowdown and recession, it cuts the federal funds rate. A reduction in the federal funds rate puts downward pressure on the interest rate for actively traded money market securities, such as Treasury bills, large denomination certificates of deposit, and commercial paper.

Depository institutions (commercial banks, savings and loan associations, credit unions, and savings banks) then reduce loan rates. Long-term interest rates will decline as well, but by a smaller amount. The increase in the supply of funds entering credit markets from depository institutions, following a lowering of the federal funds rate, also tends to lower real (adjusted for inflation) interest rates. Since real interest rates represent the cost of borrowing in terms of foregone future consumption of goods and services, a lower rate makes borrowing less costly.

How does U.S. monetary policy affect agriculture?

Easier monetary policy, accomplished by the Federal Reserve's reduction in the federal funds rate on overnight bank deposits, promotes a healthier financial environment for agriculture by reducing credit costs (through the resulting reduction in interest rates) and by increasing credit availability. An easing of monetary policy leads to greater bank liquidity over time, which leads to greater willingness on the part of commercial banks to make agricultural loans. An easing of monetary policy also reduces interest rates charged by noncommercial bank lenders, such as the Farm Credit System, equipment suppliers, and life insurance companies.

Farmers benefit because lower real (adjusted for inflation) interest rates make it easier for farmers to qualify for loans, as well as reducing farm borrowing costs. Lower real interest rates also tend to raise U.S. and world economic growth, thus raising demand for agricultural commodities. A fall in expected short-term real returns on U.S. assets relative to those available outside the United States tends to place downward pressure on the U.S. dollar. Thus, farmers will tend to benefit by increasing international demand for their products.

The effect of this loosening of credit is an improvement in the terms of trade for U.S. farmers and an incentive to expand production. Lower interest rates also result in higher farm incomes as the decrease in interest rates lowers production costs for farmers without necessarily compensating with a decrease in the price of their output. Lower interest rates further increase the incentive to invest in agriculture directly as well as in research and development, which affects productivity growth in subsequent years.

The Federal Reserve, however, must be concerned about the impacts of monetary policy on short- and long-term inflationary expectations. An overly expansionary monetary policy, for example, will harm businesses by raising inflationary expectations. Higher inflationary expectations raise nominal interest rates and lending risk premiums, and will ultimately slow real credit expansion and economic growth. Higher inflation also increases the cost of noncredit inputs to farms and other businesses.

How does a fiscal stimulus affect agriculture?

A fiscal stimulus refers to an increase in the level of government spending or a reduction in tax rates. Fiscal policy affects agriculture by altering real (adjusted for inflation) income, inflation, real interest rates, exchange rates, and long-term economic growth. The impact of a stimulative fiscal policy on the macroeconomy and agriculture depends on the magnitude of the stimulus package, the current stage of the business cycle, and how long the stimulus package is expected to be in place.

A stimulative fiscal policy typically leads to larger government deficits and greater government borrowing. In the case of higher government spending, gross domestic product is boosted directly in the intermediate term by the increase in governmental spending, and indirectly through the increased spending by those private individuals who receive higher income as a result of the government spending. A reduction in taxes boosts real output by increasing private disposable personal income, raising corporate profits after taxes, and/or by lowering corporate capital costs (through raising depreciation allowances or by increasing the investment tax credit). The greater the increase in government spending or the cut in taxes, the larger the expected boost to total real output in the intermediate term.

The stage of the business cycle is an additional important variable in determining the magnitude of the impact of a fiscal-policy stimulus. If an expansionary fiscal policy is pursued at a time when economic output is below its potential, the impact will be larger due to excess supply in the economy. If an expansionary fiscal policy is pursued in times when output exceeds long-term potential, the increase in overall output will be smaller and the inflationary pressures generated will be greater.

A stimulative fiscal policy will benefit agriculture more when actual national output is below potential. During these times, the impact of an expansionary fiscal policy on U.S. and world growth will be larger while the negative impacts on inflationary expectations, real interest rates, and the U.S. dollar are likely to be small. Fiscal-policy initiatives directed specifically toward agriculture, such as more rapid depreciation and higher investment tax credits for agricultural capital goods, are likely to be especially beneficial for agriculture.

Why are energy prices important for agriculture?

There are four primary reasons:

  • Energy-related inputs-such as gasoline, diesel fuel, electricity, and fertilizer-are over 30 percent of nonfarm-origin farm expenses. Gasoline, diesel fuel, and natural gas prices paid by farmers are directly influenced by crude oil prices. Electricity prices, while not as directly and immediately responsive to crude oil prices, move up with oil prices over the long term. Natural gas-the price of which is influenced by crude oil, as industrial and commercial users substitute among energy sources-is key to the production of nitrogen-based fertilizer. For example, fertilizer prices rose sharply in the winter of 2000-01 when natural gas prices soared, the largest increase in nitrogen-based fertilizer prices since 1974. By the winter of 2007, prices for nitrogen-based fertilizers had risen almost 60 percent above the 1974 peak-driven by sharp increases in natural gas prices.
  • Energy prices influence U.S. economic growth, driving domestic demand for food and fiber. U.S. economic growth, while only half as dependent on energy as in the 1970s, is still constrained by restrictions on available energy. There is widespread agreement that low energy prices contributed to the strong growth and low inflation experienced in the 1990s. This growth in turn spurred continually increasing demand for food and fiber products, supporting farm cash receipts.
  • Energy prices affect the growth of non-oil producing countries, particularly developing economies, which are increasingly important customers of U.S. food exports. Developing countries, which tend to focus on manufacturing, are far more dependent on oil for growth than are developed countries, which rely relatively more on services. China, for example, requires over three times more energy to produce one more dollar of gross domestic product than the United States. A large increase in energy prices has a significantly negative impact on Chinese growth. (The quick turnaround from the 1997-98 financial crisis was in part due to low crude oil prices.) Slower Asian economic growth from higher energy prices means smaller increases in U.S. farm exports.
  • Agriculture has increasingly become a supplier of energy as biofuel production from corn has expanded. For further information, see the Bioenergy topic.

Last updated: Wednesday, May 30, 2012

For more information contact: David Torgerson and Mathew Shane

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