2007 Economic Outlook
By Nancy Jorgensen

How will the economy treat you next year?
Today’s Farmer quizzes a few economists for key indicators. 

Pat Westhoff, Ph.D.
Associate Professor
Univeristy of Missouri
Food and Agriculture Policy Research Institute
Columbia, Mo.

Terry Kastens, Ph.D.
Extension Agricultural Economist
Farm Management
Kansas State University
Manhattan, Kan.

Larry Chimerine, Ph.D.
President
Radnor International Consulting
Bala Cynwyd, Penn.

1. What’s your outlook for the overall U.S. economy for 2007?

Kastens: We’ll see continued weakening of the housing market. The overall growth rate on house values could go negative; it already has in some cities. Energy prices will flatten or decline. Inflation will plug along at 3 percent—no big deal. There will be no recession.

Westhoff: Barring any unpleasant surprises, I expect another year of solid but not exceptional U.S. economic growth. Weaker housing prices might slow the economy—as housing prices have increased in recent years, consumers have borrowed and spent more than they might have otherwise. A slowdown in housing inflation and reduced prices may weaken consumer demand.
If the recent downturn in petroleum markets grows beyond a temporary blip, lower fuel prices may create a force in the opposite direction. As consumers spend less on fuel, they can afford to spend more on other goods.
In general, inflation remains relatively low by historical standards, in spite of big increases in energy costs the past 2 years. A major uncertainty is whether the slow tightening of monetary policy by the Federal Reserve in recent years has been too much or not enough. Some fear that higher interest rates will stifle the economy and see the housing slowdown as evidence that this is occurring. Others argue that interest rates weren’t raised quickly or far enough, and fear that inflation may re-emerge.

Chimerine: The economy has already shifted gears downward. Since early 2003, economic growth ranged from 3.5 to 4 percent. For 2006, we’ll probably see growth slow to something more like 2.5 to 3 percent, downsizing by about 1 percent and with more to come. In 2006 we saw speculative purchases in real estate and high energy prices put the squeeze on growth. Some families reduced purchasing, including those who took out adjustable rate mortgages.
For 2007, I expect growth of 2 percent. I think we’ll avoid a recession because our energy bills are going down. This will take pressure off most families as it becomes less expensive to heat homes and fill up our gas tanks.


2. What’s your interest rate outlook for 2007?

Kastens: Interest rates will stay flat at around 8.5 to 9.0 percent on operating and 8.0 to 8.5 percent on long-term agricultural land. Again, no big deal.

Westhoff: Markets do not expect a lot of additional increases in short-term interest rates beyond those that have already occurred, and long-term rates have remained surprisingly low in the face of increases in short-term rates and higher energy prices. Short of a recession, I would not expect a significant dip in interest rates anytime soon, but neither would I expect a sharp increase, provided foreigners don’t become overly skittish about holding U.S. dollar-denominated assets.

Chimerine: The Fed raised rates at their last couple of meetings in 2006, until October when they kept interest rates the same. I think it will be more than a pause, and their next move will likely be to cut short-term interest rates. Long term rates are coming down, too.


3. What’s the current state of farm debt?

Kastens: Farm debt in aggregate is absolutely no problem. Loan delinquencies remain low and new land buyers are solid folks, borrowing less than half the purchase cost of the land. But this doesn’t preclude isolated pockets with hard times where drought has been ongoing for years.

Westhoff: Net farm income is expected to be much lower in 2006 and 2007 than it was in 2004 and 2005. Still, for the country as a whole, the farm financial picture remains generally positive. Asset values have increased because of the run-up in land values, and debt increases have been fairly restrained.
USDA reports total farm debt at the end of 2001 at $185.7 billion and forecasts debt of $216.5 billion at the end of 2006. While that adds up to a $30.8 billion increase, asset values have risen even faster. Total farm assets (real estate, financial assets, machinery, livestock, etc.) totaled $1.26 trillion in 2001 and are forecast to total $1.81 trillion at the end of 2006. That suggests the debt-asset ratio declined from 14.8 percent in 2001 to 12 percent in 2006. These totals and averages mask a complicated picture at the farm level. A significant proportion of farms have no or little debt, while others carry sufficient debt that the income downturn we experienced over the past year can cause significant concerns.
In Missouri, some areas have been negatively affected by 2 or more years of drought and large increases in production costs, and there may well be some concerns caused by resulting declines in producer income. While the picture here may not be as positive as it is nationally, it is not as dismal as it has been at times in the past.


4. How will land prices affect farmers?

Westhoff: One of the biggest concerns is that asset value inflation cannot continue at the pace of the last few years. In much of the country, farm real estate prices have increased because of generally strong farm income, low interest rates and heavy investment from non-farm buyers. As farm income slows, interest rates rise, and as non-farm real estate markets soften, farm real estate markets may soften as well. Recent evidence suggests farm real estate inflation has dramatically slowed from what it was just a few months ago, with further weakness likely.
It’s a two-edged sword. High land values provide a major source of wealth to those who own land but present a barrier to those who do not. For farmers who own most of their land, higher land values make more money available for investment or consumption. For those who rent most of their land, high land values provide few benefits. In many parts of the country, renters face intense competition resulting in increased rental rates and tightened margins.


5. How will changes in the dollar’s value affect agriculture?

Westhoff: The dollar has weakened, but the U.S. continues to run a large trade deficit. Many believe we cannot continue to run these types of deficits forever—sooner or later foreigners will be less willing to accept pieces of paper such as U.S. Treasury bonds instead of real goods and services. If that happens, we could see a sharp decline in the dollar’s value and/or an increase in U.S. interest rates. A weaker dollar would be good for U.S. exporters—not just in the agricultural sector, but across much of the economy. It would also reduce consumer purchasing power.

Chimerine: Two things spell good news for the farm sector. One, the dollar is trending lower against other currencies, which will help us sell more agricultural products overseas. In addition, living standards are going up in places like China and India, and that means a better diet for their people.


6. How will ethanol impact farmers in 2007 and beyond?