Questions & Answers
The following are some common questions about macroeconomics and
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
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
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
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
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
How does the Federal
Reserve Board influence interest rates through monetary
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
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
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
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
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
- Agriculture has increasingly become a supplier of
energy as biofuel production from corn has expanded.
For further information, see the Bioenergy topic.