The US Federal Reserve has started raising interest rates to curb inflation. Higher rates imply higher interest charges, assuming no other changes. This article explores the role of agricultural interest charges in the US agricultural sector. Between 1982 and 2014, farm interest expense decreased as a proportion of farm cash production expenditures, from 18.3% to 4.4%.
Rising interest rates combined with the increase in farm debt since 1991 means that farm interest costs are expected to rise. A return of interest expense to its historical average share of 9.5% of cash production expenses would reduce net farm income by more than 10%, assuming no other changes.
This article accompanies the daily farmdoc article of February 18, 2022 which focused on increasing farm debt in Illinois and the United States.
Role of agricultural interest expenditure in production expenditure:
United States agricultural production and interest expense has been compiled by the United States Department of Agriculture since 1910. The role of interest expense in cash production expenditure, excluding housing operators, varied considerably, from a share of 2.8% (1947) to 21.4% (1921).
The range has narrowed only slightly over the past 50 years: 4.4% (2013 and 2014) to 18.3% (1982). Unsurprisingly, the share was highest during periods of financial difficulties for farms in the 1920s, 1930s and 1980s. agricultural cash production followed an upward trend.
Interest charges for real estate and non-real estate debt generally follow each other (see Figure 1). The largest and longest gap occurred between 1930 and 1938, when non-real estate interest expense was only one-third of total interest expense.
This low share likely reflects decisions by farms during the Great Depression to minimize cash production expenses in order to preserve cash for other uses, including paying down mortgage debt.
Change in farm debt and interest expense
Not surprisingly, there is a strong relationship between change in farm debt and farm interest charges (see Figure 2). A 5-year moving average is used to smooth the annual percentage change. The change in farm debt explained 86% of the change in farm interest expense. However, there are 3 periods in which the change in debt and interest charges diverged significantly.
- 1935-1939: Farm debt fell faster than interest expense (-7.9% vs. -3.1%) as the United States and the world began to recover from the Great Depression and the agricultural crisis associated.
- 1970-1984: Interest expense grew faster than debt (+15.1% vs. 10.4%) as interest rates rose in response to rising inflation. This period covers the agricultural prosperity of the 1970s and the beginning of the agricultural crisis of the 1980s.
- 1991-2017: Debt grows faster than interest charges (+3.7% against +0.7%). The slower growth in interest expense reflects a long period of falling interest rates (the December 23, 2021 daily farmdoc article discusses 10-year US Treasury bond rates since 1962). Since 1991, US farm debt has increased 235%, from $131.6 billion to $441.3 billion in 2020.
Between 1982 and 2014, US farm interest expense declined as a proportion of US farm cash production expenditures, from 18.3% to 4.4%. It has steadily increased since.
In 2020, U.S. farm interest expense accounted for 5.3% of U.S. cash production expenses, significantly lower than the 9.5% average since 1910.
To get an idea of what a time trajectory of rising interest rates might mean for U.S. farm income, an increase in interest expense as a share of cash production expenses from its 2020 value to its average historical value of 9.5% would result in a $13.7 billion increase in interest expense ((9.5%-5.3%) * $326.5 billion in cash generation expense in 2020).
Such an increase implies an 11.7% drop in cash net farm income based on its value of $117.2 billion in 2020 (11.7% = $13.7 / $117.2).
In summary, rising interest rates, combined with the 235% increase in farm debt since 1991, will likely put significant pressure on farm income, especially if inflation does not come down. The same concern is noted in the February 18, 2022 daily farmdoc item. Farmers and other actors in agricultural supply and production chains need to start preparing coping strategies.