What the Fed’s recent move means for small businesses
While there are many internal, microeconomic factors that dictate how successful a small business is, there are also external macroeconomic aspects that can control elements of running a company, such as seeking out and obtaining business financing. One such external factor involves the U.S. Federal Reserve and its ability to raise interest rates – an action the central bank chose not to implement at its March 15-16 Federal Open Market Committee meetings, The New York Times reported.
What the Fed’s been up to lately
As the institution responsible for controlling the country’s monetary policy, the Federal Reserve can greatly impact how much money is in circulation, how much institutions are charging to lend out this money as well as many other important economic factors. One of the main tools the Fed uses to maintain its monetary policy is its benchmark short-term interest rate. This mechanism can ultimately affect everything from how much groceries cost to how many people have a job.
High interest rates means capital costs more to borrow, while low interest rates make it less expensive. At the height of the Great Recession, the central bank pushed its interest rate down to near zero for the first time in history. The policymakers chose to do this due to the fact that credit had dried up, and they wanted to spur bank lending to stimulate the economy. It took some time for the economic recovery to take hold, and while the nation pulled itself out from the nadir of the recession, interest rates stayed at 0.0-0.25 percent.
The Fed kept its interest rates at this near-zero level from December 2008 until December 2015, when the central bankers felt the economy could handle a rise in the cost of capital. During this seven-year period of near-zero rates, a great deal of small businesses opened and closed their doors, many entrepreneurs embarked on new enterprises and the economy evolved immensely.
At its Federal Open Market Committee meeting in December 2015 when it lifted the rate from 0.0-0.25 percent up to 0.25-0.5 percent, Fed Chair Janet Yellen indicated that the central bank planned on gradually increasing this level four times in 2016, to reach 1 percent. However, despite strong economic indicators and a stabilizing economy, the volatility that wracked the U.S. stock markets at the beginning of the year created too much uncertainty, and, as noted, the Fed did not lift rates during its March FOMC meeting.
What this means for small businesses
There are several ways the Federal Reserve’s moves – or lack thereof – influence small businesses. First, the rising level of interest rates makes capital more expensive, which means those owners looking for a small business loan may potentially end up paying more in the long run. While this isn’t always the case, it’s a concern that must not be overlooked. However, many alternative lenders are not bound by this prime rate the same way traditional banks are, which provides many more options for small business owners seeking out capital.
Another way the central bank influences small businesses is through perception and confidence. A rate hike indicates the economy is strong enough to withstand more expensive capital and a stronger dollar. This is psychologically reassuring for small business owners, essentially giving them a green light to undertake expansion plans, hire more workers or purchase more inventory. Alternately, by not raising interest rates, the Fed is ultimately saying that economic conditions might not be as optimal as expected.
Despite the inaction the Fed’s part, according to CNBC, the Fed will not hike rates into weakening conditions, a move which could bring additional economic woes. However, with the uncertainty surrounding the central bank’s decisions moving forward, small businesses could potentially benefit from a working capital loan if necessary.