Sign up for Funding Circle newsletter!
Get our latest news and information on business finance, management and growth.
Updated: March 27th, 2020
In spite of a strong economy and low unemployment rate, fears of a pending U.S. recession continue to dominate the news. And recently, the Federal Reserve announced it would lower interest rates for the second time since July, affecting businesses across the country.
The Fed cut interest rates by a quarter-point, and some officials expect another cut later this year. Chairman Jerome Powell said the Fed would act more aggressively if the economy shows signs of weakening.
Lowering the federal funds rate is a decision that will impact consumers and businesses alike. This article will explain why the Fed lowers or raises interest rates and answer the question of “how do low interest rates affect a business?”.
The federal funds rate is a tool the Fed uses to meet these three economic goals:
Think of the rate like a lever that the Fed raises or lowers depending on current economic conditions.
The Fed lowers interest rates to stimulate the economy and provide more spending power to Americans. For instance, during the Great Recession, the Fed cut interest rates effectively to zero for seven years. This led to historically low interest rates on loans like mortgages and car payments.
So, how do low-interest rates affect a business? Lower fed rates can spur consumer spending and make it easier for Americans to take out low-cost loans. Similarly, low interest rates make it easier for businesses to borrow money and then use this money to grow their company.
High interest rates are only put in place when the economy is good because they lower consumer income. In terms of the impact of higher interest rates, it becomes expensive for consumers and businesses to take out a loan. So, they tend to hold onto their money longer.
Another impact of higher interest rates is that they tend to slow the pace of business investment. That’s because it becomes harder for businesses to take out loans. Companies that do take out loans will spend longer paying off this debt.
All businesses will perform best in an economy that is healthy and growing. And most companies leverage debt as a way to fund business expansion. Here are three ways that low interest rates affect a business.
If interest rates are low, that means customers are paying less money for their mortgages, car payments, and other loans. This means they have more disposable income and can buy more products and services. So, low interest rates can spur business growth.
One impact of higher interest rates is that many companies will choose not to fund expansion projects, which slow overall business growth. On the other hand, lower interest rates make it easier for businesses to borrow money, which spurs business growth.
Going back to the question of what effect do low interest rates have on a business investment, consumers and businesses who save money in interest-bearing accounts will earn less when interest rates are low. Most people will use this money for other investments, which can cause banks to lose out on profits.
And when interest rates are low, banks won’t earn as much from lending money. So, if interest rates stay too low for too long, banks may become less willing to take risks on loans. This can make it harder for less creditworthy businesses to take out loans.
All in all, when it comes to the question of how do low interest rates affect a business, the federal funds rate is a balancing act that the Federal Reserve has to monitor closely. The rate is raised and lowered depending on current economic conditions.
And the federal funds rate has a significant impact on small business funding. When the economy is strong, interest rates will usually be higher, making loans more expensive to take out so consumers and businesses alike will have less money to spend. But if the rates stay too low for too long, banks can become more selective about their lending decisions.
Louis DeNicola is the president of LD Money Media LLC and an experienced finance writer who specializes in credit, personal finance, and small business finance. Within the small business sphere, he helps business owners understand their financing options, cash flow management, business credit, and taxes. In addition to Funding Circle, you can find his work on BlueVine, Credit Karma, Experian, Wirecutter, and Lending Tree.