The Imperfect Nature of Interest Rate Decisions

I am hoping to be driving a combine through my first soybean field tomorrow. It certainly feels like a long season to me this year even though this would be an early start.  Most of my soybeans are still at least three weeks away having been replanted in a very difficult spring. As a lookout on the fall harvest, I’m hoping for good things. However, I cannot get over all the changes we’ve seen this year aside from what is growing in the fields.  When those soybeans were planted, we were still adjusting to a world awash in all kinds of geopolitical factors affecting our bottom line. Six months later we are seeing some economic levers being pushed to try to make things better.

Interest rates are one of those economic levers. Throughout my career explaining interest rates has always been one of the tenants of showing how agricultural economics works.  35 years ago, when I started writing this column it was easy to explain interest rates because they were double digit high and a significant expense on the farm.  Then came the era of super low interest rates over the last five to 10 years where money was more of a commodity. However now interest rates have started to rise again in fact in the United States are 40% higher than they were a year ago

Keep in mind that a 40% increase of a very small number makes for a great headline. However, we got a reminder last week that our interest rate world is continuing to evolve into something much higher when the US Federal Reserve weighed in with a 75-basis point increase in their policy rate. It’s now 3.25% which is a 14 year high as the US Fed continues to try to hammer inflation by making money scarcer.  With an US inflation rate of 8.26% the Federal Reserve is pulling the interest rate lever hard.

The inflation rate in Canada is sitting at 7% which is down from where it was a month ago but still far higher than the 2% that the Bank of Canada desires.  The Bank of Canada will likely have to respond to what the Federal Reserve did by raising interest rates again. At a certain point this is going to turn into real money for Canadian farmers. The question is what is the future and where do we go from here?

It is a difficult puzzle.  It is not as easy as saying raising interest rates will tame inflation. However, from a classical sense that’s what’s happened in the past. The problem that the decision makers have in our central banks is the specter of all the negative economic effects from higher interest rates. For instance, if you raise interest rates too high then you have a real slowdown in economic activity, which could cause the economy to go into recession and raise unemployment.  If you do nothing, keeping interest rates low inflation starts to feed upon itself and get higher.  This makes it difficult for a lot of people to keep up. Central bankers don’t always get it right.

For instance, U.S. economic growth is forecast to be a paltry .2% this year and 1.2% next year.  that’s pretty low compared to normal but at least it’s positive. To give you some idea of what’s real bad take a look at Russia which is expected to see at GDP decline of 12% this year. I know that’s an extreme example, which causes much hardship for their people. However, having positive economic growth rates even if they are low are better than the alternative. Needless to say, raising these rates could still push North America into a recession and that’s someplace we don’t want to go.

In this column we’ve talked a lot about inflation this year because we all know about fertilizer prices. At the same time, you could almost argue that commodities have been a hedge against inflation as have land prices.  That gives farmers at least a step up compared to the alternative. However, it is made it very difficult for younger farmers moving into the industry especially at a time when interest rates are headed even higher.

I don’t see things getting out of hand on interest rates like back to the stone age when I was young. In fact, 20% interest rates almost seem like science fiction. However, with Russia calling up 300,000 more reservists for their war effort in Ukraine it shows how volatile our position is. Geopolitical shocks have a real impact on our interest rate direction and the associated costs on the farm.   In lieu of that, I like to trust the direction from the US Federal Reserve or the Bank of Canada as imperfect as it is.  They offer all kinds of reasons for their policy direction.  As my combine heads to the field tomorrow, I’m hoping for a nice even ride.