One of the government’s biggest levers to control our economy is interest rates. For example, in 2008 the federal funds rate was lowered to 0.25 percent in response to the economic recession, and it wasn’t raised until December 2015. In contrast, the federal funds rate was set at 20 percent in 1980 during a period of rapidly rising inflation.
Given the current rising pressure on inflation (think of our low unemployment rate and the potential impact of an increased minimum wage in many states), the Fed may be poised to increase rates again in 2019.
Below are nine of the most prevalent ways that higher interest rates impact businesses and business owners:
- Most directly, higher rates impact borrowing costs. When businesses are paying more to borrow, they have less money available to invest in people, processes, machinery, etc. New investments must have a higher perceived return on investment since the cost of borrowing is higher.
- They also impact the rate the government has to spend on its borrowing. This could ultimately lead to higher taxes.
- Rising rates lower consumer confidence. This tends to discourage investment from business owners and often leads to higher unemployment as businesses become reluctant to invest in people.
- There is more incentive to save versus spend. Higher interest rates usually entice individuals and business to save more, since they are benefiting from a greater return on their investments.
- There is downward pressure on stocks. In a higher interest rate environment, investors tend to move money out of stocks and into fixed rate investments.
- Banks may be more willing to lend since the spread between borrowing costs and returns on loans increases (at least in the short term).
- Overleveraged companies – those that have excess debt compared to their equity – suddenly have higher borrowing costs and cannot afford to pay their vendors. Loan defaults and bad debt expenses tend to increase.
- Real estate prices are typically negatively impacted. Because mortgage payments increase when rates go up, buyers often begin to seek lower-priced properties or delay their plans altogether, causing prices to fall.
- Inflation is brought under control. When consumers are more incentivized to save than spend, the resulting lower demand for goods and services tends to keep prices – and inflation – in check.
As interest rates began to rise in 2018, we noticed that business owners became more conservative about making investments in their businesses and many opted to pay down variable interest debt. It will be interesting to keep an eye on these trends as the year progresses and the Fed conducts its 2019 meetings.
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