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Feds impact on small business

Updated: Aug 30, 2023

The Federal Reserve's Impact on Small Enterprises: Credit Dynamics and Economic Implications


In a significant move reminiscent of Volcker's inflation battle in the 1980s, the Federal Reserve has swiftly increased its policy rate. Over the course of just a year, the policy rate has surged from near 0% to almost 6%. This shift has yielded a positive consequence for individuals with savings accounts, who are finally witnessing a reasonable return on their investments, although it's important to note that this return is nominal rather than adjusted for inflation. Conversely, this policy adjustment has led to a substantial uptick in loan rates for small businesses, skyrocketing from a low of 4% to over 8%. This increase in credit costs has rendered credit significantly more expensive for these businesses.


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Feds impact on small business


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However, the primary concern for small firms isn't just the elevated cost of credit, but rather the availability of credit that is essential for maintaining their financial operations. The smooth flow of cash is vital for ensuring successful business activities. In the historical context of 1980, companies were grappling with an average loan rate of 19% amid an environment of double-digit price hikes due to inflation.


A brief history

Since 1981, the National Federation of Independent Business (NFIB) has been conducting a credit market experience survey among its approximately 300,000 member firms. This survey captures insights such as the interest rate paid on the most recent loan. Research indicates the close correlation between the interest rate paid by the government for borrowing and the average rate paid by small enterprises. When the Federal Reserve raises its policy rate, it triggers an across-the-board increase in credit costs. This is due to the fact that lenders, including banks, need to offer higher interest rates to attract funds from depositors and investors, which they then lend out. This pattern is also observed in mortgage rates, which are commonly tied to the 10 Year Treasury bond.


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What business owners think

Looking at the ease of securing loans, only 8% of respondents indicated that their most recent loan was "harder" to obtain compared to their previous one, with none stating it was "easier." This is a significant contrast to the figures recorded in October 2008 when 16% reported it was "harder," and none found it "easier." Moreover, in April 1980, during Chair Volcker's intensive fight against inflation, 31% reported it was "harder." Presently, credit markets have remained largely favorable since the Federal Reserve's recent interest rate hikes. However, insights from the Federal Reserve's Senior Loan Officer Opinion Survey on Bank Lending Practices highlight a definite tightening of credit criteria among both large and small banks.


What business owners are saying

Inquiring about credit needs being met, the survey data shows a series-low net of 16% of owners reporting positively in October 2010. This figure rose to 27% in favor and 11% against. During the prosperous economic phase of July 2020, 35% stated that their credit needs were met, while only 3% reported otherwise, coinciding with low unemployment rates and inflation below 2%. Most recently, the figures have shifted to 25% reporting their credit needs being met and 3% indicating they were not, signaling a welcoming but not overly enthusiastic sentiment. Yet, despite these conditions, credit restrictions haven't escalated significantly – at least not yet.


What's in store

It's unlikely that the Federal Reserve will substantially raise rates, avoiding a repeat of the setbacks observed in the 1980s or 2008. However, maintaining higher rates will exert downward pressure on the economy. Although it takes time for elevated rates to impact spending and investment, they will continue to suppress spending even without further rate hikes. Fiscal policy is expected to remain stimulative unless Congress opts to curtail it. This could complicate the fight against inflation as government spending supports prices. The cost of living has notably surged over the past year, and unless wages keep up at the same pace (which hasn't been the case), real earnings will decline. Ultimately, this will lead to reduced spending and lower prices, eventually addressing the issue of "inflation."


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Conclusion

In conclusion, the Federal Reserve's recent policy adjustments are influencing the credit landscape for small businesses. While concerns about the rising cost of credit exist, the availability of credit remains pivotal for the financial health of these enterprises. Current trends suggest that while credit markets have tightened to some extent, they are still relatively accommodating. The broader economic impact of these adjustments, particularly on spending, investment, and inflation, will continue to unfold in the coming months.

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