Effects of interest rate changes on midwestern U.S. farmland values

The U.S. Department of Agriculture (USDA) estimated that over 83% of the 2018 farm sector’s assets were held in real estate. In this study, the effects of recent interest rate hikes on Midwestern farmland values were quantified by developing three first-order autoregressive distributed lag models using annual, inflation-adjusted, state-level farmland value and gross farm income data and real federal funds rate levels. The model estimations used observations from 1963 to 2015 and were evaluated with out-of-sample forecasts for 2016 and 2017. Results were robust with Arellano-Bond estimation and an error correction model. A one-percentage point increase in the federal funds rate induced an immediate decrease in farmland values of nearly 1%. Immediate effects were small in magnitude; however, median lag length calculations indicated that long-term impacts of changes in interest rates are much larger. In the long-run, a one-percentage point increase in the federal funds rate generates an overall decrease in farmland values of 25% in the I-states (IL, IN, IA) and Lakes (OH, MI, MN, WI) regions, and a decrease of 43% in the Great Plains (MO, KS, NE, ND, SD) region. Results indicate that it takes six, nine, and eleven lags for half of the farmland value decrease to occur in the I-States, Lakes, and Great Plains, respectively. The substantial long-term effects of interest rate hikes and the projected future increases of the federal funds rate indicate that this study has direct implications on monetary policy, especially considering the growing farm financial stresses resulting from farm income declines.