Macroeconomics in Agriculture

1
Macroeconomics in Agriculture

• John B. Penson, Jr.
• Regents Professor and Stiles Professor
• Department of Agricultural Economics
• Texas AM University

2
Some Background

• Major professional influences
• Chet Baker
• Past President and Fellow, AAEA
• Quantitative analysis of domestic and
  international finance issues
• Walter McMahon
• Professor of Economics, Education and Medicine,
  University of Illinois
• Macroeconomic modeling
• Ed Schuh
• Regents Professor, University of Minnesota and
  AAEA Fellow
• New macroeconomics of Agriculture
• Macroeconomic linkages to the U.S. food and fiber
  industry
• Case example the Feds efforts to control
  inflation in the early-1980s and the economic
  impacts on the food and fiber industry

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Important Economic Linkages
US macro policy
ROW macro policy
Domestic real economy
Domestic capital and credit markets
ROW capital and credit markets
ROW real economy
Farm business sector
Farm Input supply sectors
Food and fiber manufacturing sectors
Wholesale and retail trade sectors
Commodity policy
Food, resource and environmental policy
Farm and non-farm labor markets
Farm credit markets
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Case Example

• Fed actions to fight inflation in the 1980s
• Tightened money supply beginning in 1979 to fight
  double digit inflation.
• The fed funds rate rose to 20 percent and the
  prime interest rate reached 21 percent.
• Impacts on producers, farm input supply firms and
  financial intermediaries
• Real short and intermediate term interest rates
  on farm loans rose dramatically, causing interest
  payments paid by producers to increase from 7 to
  19 of variable costs of production
• Net farm income fell dramatically as a result, in
  part, of rising interest payments and rising
  energy prices occurring at this time
• Farm land values fell, undercutting the security
  for farm mortgage loans
• Capital investments for machinery and other
  assets fell, causing sales by John Deere and
  other fixed input manufacturers to fall
• Responses to these impacts
• Producers surviving this environment paid down
  debt over the ensuing years
• Farm input supply firms diversified their
  operations
• Financial intermediaries initially placed more
  emphasis on cash flow lending as opposed to
  overemphasis on collateral lending.

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Four Key Trends in the 1980s
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Study of Non-Farm Business Failures Seeds of
Default
Failed
Failed
Implies a debt burden ratio of 5.0
Failed
Failed
Source W. H. Beaver, Financial Ratios and
Predictors of Failure, Journal of Accounting
Research
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Impact on Debt Repayment Capacity in the 1980s
Reciprocal of ratio from Beaver study
5.0
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Impact on Debt Repayment Capacity in the 1980s
Importance of supplemental appropriations during
Asian Flu Crisis
5.0
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Three Themes

• Macroeconomics in agricultural economics research
• Macroeconomics in undergraduate agricultural
  economics classrooms
• Macroeconomics in agricultural lending decisions

10
Macroeconomics in Research

• Choices in research focus
• Explaining past events vs. What if policy
  analysis
• Partial vs. general equilibrium, open vs. closed
  economy
• Choices among methodologies
• Econometric models (time series, structural
  multiple regression)
• Mathematical programming models (IOs, CGEs)
• Measurement and simulation issues
• Measurement of variables (e.g., cost of capital
  in modeling investment expenditures at sector
  level)
• Deterministic vs. stochastic treat macro trends
  as random variables
• Endogeneity of macroeconomics linkages
• Stand alone vs. recursive vs. fully simultaneous
  models)
• Applicable in LDCs and DCs
• Examine sensitivity of research conclusions when
  simulating beyond sample period using alternative
  assumptions for exogenous macroeconomic variables.

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Macroeconomics in Classroom

• Students are generally curious about current
  macroeconomic events in the news.
• My experience at Texas AM
• Senior level course in macroeconomics of
  agriculture
• In class development of IS-LM open economy model
  for a mythical country
• Class divided into teams each must develop a
  plan for a startup company in this country using
  risk adjusted NPV analysis
• I give each team a set of random GDP and market
  interest rates to hit using available monetary
  and fiscal policy tools
• Once targets are reached, teams assess the
  sensitivity of their business plan to events in
  the general economy
• Macroeconomics instruction in 10 Southern
  departments and 5 departments outside the south
• Based on review of curriculums found in
  university catalogs
• Of 15 departments, only three (Florida, Minnesota
  and Texas AM) have upper level courses focusing
  on linkages between agriculture and general
  economy.
• Students should be able to relate global and
  domestic economy events to their major.

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Macroeconomics in Lending

• Lenders and regulators must
• Meaningfully assess exposure to credit risk (a
  Basel pillar) when making loan and portfolio
  decisions
• Stochastically evaluate the probability of
  default and loss given default when identifying
  potential problem loans and when establishing
  loan loss reserves
• Importance of sensitivity analysis of debt
  repayment capacity on long term loans for
  portfolio externalities.
• Require multi-year pro forma financial statements
  similar to traditional requirements for large
  commercial loans
• Benchmark analysis for key portfolio segments as
  part of an early warning system
• Importance of monitoring migration of loans
  across loan classifications after the loan is
  made.
• Portfolio data base mining based on credit
  standards
• Probability of default increases as loan lapses
  to non-accrual status

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Challenges Ahead

• Increasingly sensitive to global economic events.
• The cost of imported goods and services will
  exceed federal revenues for the first time ever
  this year, underscoring the increasing influence
  of the global economy on our economy.
• Fed has raised interest rates 17 times since
  2004, yet the 10-year bond rate is exactly at the
  level it was in 2004!
• Unemployment, inflation and interest rates low by
  historical standards, but real wages are down
  over the past five years. The savings rate in the
  US is now consistently negative.
• Future entitlement obligations will squeeze some
  discretionary government spending programs.
• What does this mean for the capital intensive
  sectors in the U.S. food and fiber industry?

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Is the sky falling? No. Are there scenarios that
should not be ignored? Yes
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Three Theme Wrap Up

• Research Treat domestic and global macroeconomic
  influences as random variables when analyzing
  future policy alternatives, forecasting prices,
  etc.
• Classroom Undergraduate curriculums are
  fundamentally micro in theory and applications.
  Students, however, need to be able to relate
  macroeconomic events to their major.
• Financial markets Important that lenders and
  regulators recognize emerging risks to future
  farm debt repayment capacity and use early
  warning system to identify pockets of potential
  risk in loan portfolios.