How the Federal Reserve Can Affect Agriculture 2012 2013 Ag Profitability Conferences Brian C. Briggeman Associate Professor and Director of the Arthur Capper Cooperative Center The Federal Reserve System Established in 1913 Third attempt at a U.S. central bank Four general areas of focus: Conduct monetary policy Supervise and regulate banking institutions Provide financial services Maintain stability of financial system (systemic risk) Background on the Federal Reserve 1
An Independent Federal Reserve System The Fed generates its own income Service income Interest income Loans and U.S. Treasury securities In fact, the Fed is a for profit institution All profits go to the U.S. Treasury Balance of Power: The Political Fight for an Independent Central Bank, 1790 Present http://www.kc.frb.org/ Background on the Federal Reserve Fed Structure: Board of Governors is Washington, D.C. Representation Background on the Federal Reserve 2
Fed Structure: Regional Reserve Banks is the Wall Street and Main Street Representation Background on the Federal Reserve Fed Structure: Primary Decision Making Body is the Federal Open Market Committee (FOMC) Background on the Federal Reserve 3
Objectives of Monetary Policy Stable prices Keep inflation under control (not too high and not too low) Full employment Work to keep unemployment rate from being too high The Federal Reserve s Monetary Policy Tools The Federal Reserve s Monetary Policy Tools 1. Open Market Operations 2. Discount Rate 3. Bank Reserve Requirements 4. Balance Sheet (Quantitative Easing) The Federal Reserve s Monetary Policy Tools 4
The Federal Reserve System and U.S. Agriculture Difficult to definitively argue causality Effects of the Fed on U.S. Ag 1. Interest rates a. Arguably most significant driver 2. BIG balance sheet and bank excess reserves a. Inflation 3. Access to credit 4. Value of the U.S. dollar 5. Farmland values Effects of the Federal Reserve on U.S. Agriculture With the economy still in a sluggish recovery, the Fed has kept interest rates near zero. Percent 6 Fed Funds Rate (Upper Bound) 5 4 Zero Bound Until 2015? 3 2 1 0 Jan-07 Jun-07 Dec-07 Jun-08 Dec-08May-09Nov-09May-10Nov-10 Apr-11 Oct-11 Apr-12 Oct-12 Source: Federal Reserve Board of Governors Interest Rates 5
While the zero bound is a new issue in monetary policy, excessively low and negative real interest rates are not. Percent 20 Real Commercial Paper Rates 15 10 5 0 5 10 15 Negative Real Interest Rates 1910 1914 1918 1922 1926 1930 1934 1938 1942 1946 1950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 Source: Featherstone, Allen M. and Timothy Gl. Baker. 1987. An Examination of Farm Sector Real Asset Dynamics: 1910 85. American Journal of Agricultural Economics 69(3): 532 546, and Federal Reserve Board of Governors How does monetary policy work when nominal shortterm interest rates are at the zero bound? Central Bank 1 2 Short term interest rates Bank Reserves 3 Bank Credit Excess Reserves Long term Interest rates Economic activity Source: Gordon Sellon (2003) Monetary Policy and the Zero Bound: Policy Options When Short Term Rates Reach Zero Economic Review http://www.kansascityfed.org/publicat/econrev/pdf/4q03sell.pdf Interest Rates 6
3,000 2,500 2,000 The Fed has pumped massive amounts of liquidity into the marketplace. Billion Dollars 3,500 Fed Agency Debt Mortgage Backed Securities Purchases Liquidity to Key Credit Markets Lending to Financial Institutions Long Term Treasury Purchases Traditional Security Holdings 1,500 1,000 500 0 Source: Federal Reserve Bank of Cleveland BIG Balance Sheet and Bank Excess Reserves With interest rates at historically low levels, bank liquidity has surged. To stimulate the economy, the Federal Open Market Committee (FOMC) dropped the Fed funds rate to the zero bound and pumped liquidity into the market (QE 1, 2 and 3). With low interest rates, large amounts of liquidity and limited to no borrowing activity, excess reserves of depository institutions held at the Fed surged. Ample funds are available for businesses and individuals BIG Balance Sheet, Bank Excess Reserves and Access to Credit Fed Funds Rate and Excess Reserves Percent Billion Dollars 8 2,000 6 4 2 0 Upper Bound of Intended Federal Funds Rate (Left Axis) Jan 07 Sep 07 May 08 Jan 09 Sep 09 May 10 Jan 11 Sep 11 May 12 Source: Federal Reserve Board of Governors Excess Reserves of Depository Institutions (Right Axis) 1,500 1,000 500 0 7
Inflation? Today, monetary policy is extremely accommodative Bank excess reserves are large and interest rates are low Liquidity effect So, what about inflation and the expectations of future inflation? BIG Balance Sheet and Bank Excess Reserves Today s inflation is well below 1970s levels Personal Consumption Expenditures Price Index Percent change from previous year 14% 12% 10% 8% 6% 4% 2% 0% 2% PCE Price Index (Headline) PCE Price Index Excluding Food and Energy (Core) Jan 71 Dec 72 Nov 74 Oct 76 Sep 78 Aug 80 Jul 82 Jun 84 May 86 Apr 88 Mar 90 Feb 92 Jan 94 Dec 95 Nov 97 Oct 99 Sep 01 Aug 03 Jul 05 Jun 07 May 09 Apr 11 Source: Federal Reserve Economic Data, Federal Reserve Bank of St. Louis BIG Balance Sheet and Bank Excess Reserves 8
and inflation expectations are very low. 7% 10 year Inflation Expectations 6% 5% 4% 3% 2% 1% 0% Jan-82 Jan-83 Jan-84 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Source: Federal Reserve Bank of Cleveland BIG Balance Sheet and Bank Excess Reserves Exchange rates are exceptionally low, which plays a role in determining corn prices. Exchange Rate and Corn Price Indices Index = Jan. 2000 120 110 Trade Weighted Exchange Rate (Left Axis) Real Corn Prices (Right Axis) Financial Crisis 2 Index = Jan. 2000 300 225 100 3 150 90 1 75 80 Jan 00Jan 01Jan 02Jan 03Jan 04Jan 05Jan 06Jan 07Jan 08Jan 09Jan 10 Jan 11 Jan 12 Source: Federal Reserve Board of Governors and Chicago Board of Trade Value of the U.S. Dollar 0 9
Interest rates can affect farmland values through two avenues. Expected Farm Income Interest Rates = Farmland Values Capitalization Rates Value of the U.S. Dollar and Farmland Values Over time, real interest rates and capitalization rates tend to move together. 10.0 Kansas Capitalization Rate and Real Interest Rate 8.0 6.0 Percent 4.0 2.0 0.0 Kansas Cash Rent to Land Value Ratio 2.0 Yield on 10 year U.S. Treasury Security adjusted for inflation 4.0 1970 1975 1980 1985 1990 1995 2000 2005 2010 Sources: USDA, Federal Reserve and BLS Value of the U.S. Dollar and Farmland Values 10
Over time, real interest rates and real net farm income tend to move in opposite directions. Real Net Farm Income and Risk Free Rate Constant 2005 Dollars (Billions) 125.0 100.0 75.0 50.0 25.0 Real Net Farm Incomes Less Government Payments (Left Scale) Real 1 year U.S. Treasury Securities Yield (Right Scale) 7.5 5.0 2.5 0.0 2.5 Percent 0.0 1970 1975 1980 1985 1990 1995 2000 2005 2010 Sources: USDA, Federal Reserve, BLS Value of the U.S. Dollar and Farmland Values 5.0 Historically low capitalization rates help support current cropland values. Dollars per Acre 7,000 6,500 6,000 5,500 5,000 4,500 4,000 3,500 3,000 2,500 2,000 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0% 6.5% 7.0% 7.5% 8.0% Cropland capitalization rate Authors calculations based on KSU Corn Cost return Budget in South Central Kansas. Assumed 200 bushels per acre, a corn price of $4.75 per bushel, and 20% of gross revenues capitalized into land. Value of the U.S. Dollar and Farmland Values Kansas Capitalized Irrigated Cropland Values 11
At a historical average cap rate and today s corn prices, current cropland values in Kansas are reasonable. 5,500 Kansas Capitalized Irrigated Cropland Values 5,000 4,500 Dollars per Acre 4,000 3,500 3,000 2,500 2,000 1,500 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5 8.0 Corn price (dollars per bushel) Authors calculations based on KSU Corn Cost return Budget in South Central Kansas. Assumed 200 bushels per acre, a corn price of $4.75 per bushel, 20% of gross revenues capitalized into land, and cap rate of 6.5%. Value of the U.S. Dollar and Farmland Values Thank you. Questions? 2012 2013 Ag Profitability Conferences Brian C. Briggeman Associate Professor and Director of the Arthur Capper Cooperative Center 12