This year's drought was of historic proportions and has had a ripple effect through the entire economy. Although farm output is barely 1%, this summer's drought reduced Gross Domestic Product growth by 0.4% as many other sectors continue to struggle, according to the latest government statistics.
The Commerce Department reported that the U.S. economy grew at a modest 2% annual rate in the third quarter from July through September.
Jeet Dutta, senior economist at Moody's Analytics, said the Q3 impact was actually slightly above expectations of 0.3%, but he expects just a 0.1% impact for the remainder of the year.
"I think we have already felt most of the impact of the drought on the GDP," he noted.
Much of the impact comes as grain and commodity stocks are drawn down. Dutta said the secondary impact results from higher food prices, which haven't all worked through the system yet.
"For the most part we are still anticipating higher food prices in the fourth quarter and the first quarter of 2013, which effectively reduces the real GDP," he said.
Farm output is lower, which also has led to livestock and poultry producers cutting back on production. Dutta noted that the food prices will be "manageable" but because the supply and demand balance is so tight right now, even small supply destruction around the world could lead to large spikes in prices again.
"We are off the late summer levels when the drought was having its maximum impact. Although grain prices remain elevated, other inputs such as sugar and cotton have stayed down," he said. "The overall impact of farm commodity prices remains fairly moderate or at least manageable in the months ahead. However, that balance could be upset very easily."
Food price impacts were expected to show up in the third quarter, but Dutta stated that didn't happen. The food component of the Consumer Price Index was expected to climb by 3%, but instead came in closer to 2%. "We think the impact is still going to feed through the food supply change." Moody's expects the year ago change of the food component of the CPI to be above 3% by mid-2013 and in the mid 2% to 3% range over the next six to nine months.
Dutta noted that normally the farm sector does not have a major impact on the nation's GDP. Because so many other, bigger segments are weak right now and not contributing to growth, the "farm sector has acquired more importance than it normally would," Dutta said.
"A 0.4% deduction would not have felt so dear if other parts of the economy would have been healthier. Growth is so anemic and hard to come by from other sectors that normally would be contributing more," he said.
Because of lower incomes among farmers, they are going to be spending less on their retail spending and also bigger ticket items such as farm equipment.
"The extent to which farmers are cutting back on spending is mitigated by the fact farmers have crop insurance and other forms of support. Property and land values are still elevated, which still supports spending by farmers," Dutta said.
Midwest merchants are expecting a weak holiday season in part because farmers have curtailed their spending. Lower water levels in the Mississippi River that stranded barges have also caused costly shipping delays, reports indicate.