May 24, 2006 | By: Aimee Nielson

Despite 2005 hurricanes and the recent spike in oil and gasoline prices, the U.S. economy is doing surprisingly well. Economic growth in 2005 was a solid 3.6 percent and growth for 2006 should be in the mid 3-percent range.

Still, University of Kentucky College of Agriculture Economist Larry Jones said that every economic slowdown in the United States since 1970 has been led by a spike in energy prices. Every week of continued high prices for oil raises the risk of economic drag because filling up at the gas pumps leaves less money for consumers to purchase other things, he said.

Agriculture requires lots of energy. Jones said higher energy prices will result in higher costs for gasoline, diesel fuel and energy-derived inputs such as chemicals and fertilizers. 

“Higher prices mean higher expenses,” he said. “Where are energy prices going as we look ahead? Some have argued the current ‘run up’ is simply a short-run price spike. Others feel the higher prices are here to stay. We do know that worldwide, demand is strong – not only in the United States. Rising economies of India and China are playing a key role.”

Supplies are relatively tight and Jones explained that strong world demand means higher prices, but it takes time for any higher price incentives to increase exploration and production. Political uncertainty in some oil-producing regions of the world adds to expectations of possible higher prices including countries such as Iran, Iraq, Nigeria, Russia and Venezuela, he said.

Higher energy prices are also being reflected in how fast inflation is increasing. The last monthly inflation number came in at a 4.3 percent annual clip, which Jones said is substantially up from the inflation rate of the past several years and that one of the consequences could be a rate hike by the Federal Reserve.

“Higher inflation will likely mean higher interest rates,” Jones said. “That also increases the cost of doing business for farmers.”

Another UK Agricultural Economist, Craig Infanger said Americans may be realizing that the days of low interest rates may have come to an end.

“With gold prices bouncing around $700 an ounce, oil around $70 a barrel and other commodity prices rising, the Fed is still worried about inflation as the economy continues to expand,” he said.

Earlier in May, Infanger said, the Federal Reserve bumped short-term interest rates another quarter-point to 5 percent. As a result, major banks pushed the prime rate to 8 percent and the Treasury T-bill auctions on six-month notes hit 5 percent, which is almost a doubling in just one year. And, the government is set to announce a jump in student loan interest rates as well, Infanger noted.

“Higher interest rate trends are hitting home in Kentucky,” he said. “Home mortgage rates have trended up slowly over the last two years, but the biggest change has been the spread, or difference, between fixed and adjustable rates.”

While homebuyers used to be able to get adjustable-rate mortgages for 3.5 to 4 percent, they are now finding fixed rates around 6.5 percent.

For Kentucky farmers, Infanger said the biggest impact of rising interest rates is on short-term borrowing for equipment and operating loans. To deal with higher interest rates, he recommends prudent financial managers manage short-term debt; lock in fixed-rate loans for real estate or major equipment purchases and shop around for the best rates.

“But beware of internet scams that seem too good to be true,” he added. “They usually are too good to be true.”



Larry Jones 859-257-7289, Craig Infanger 859-257-7274