Higher Interest Rates and Small Business

By SBE Council at 22 November, 2022, 11:01 am

by Raymond J. Keating –

In the most straightforward terms, the interest rate on a loan is the price that borrowers, including small businesses, have to pay to get money now for whatever purpose, such as investing in new equipment.

Therefore, it’s no surprise to see that a recent poll of small business owners conducted for The Wall Street Journal found that rising interest rates were having a negative effect. The Journal noted:

“Forty-six percent of small-business owners said higher interest rates are affecting their business, according to a November survey of roughly 600 small businesses for The Wall Street Journal by Vistage Worldwide Inc., a business coaching and peer advisory firm. Another 25% of those surveyed said rising rates hadn’t yet had an effect, but anticipated they would.”

Higher interest rates are increasing costs for small businesses, as well as for their customers. As noted in the report:

“For small businesses, those rate increases translate to higher costs on everything from credit cards to lines of credit to variable-rate small business loans. New financing has also gotten more costly,” and rising interest rates “have already hurt sales.”

The following chart shows the trend on the bank prime rate, which is used to price short-term business loans.

Source: Federal Reserve Bank of St. Louis, FRED

Toss inflation into the mix, and matters get riskier and more uncertain. The interest rate charged to small businesses for lines of credit or various investments is the money interest rate, which includes the real interest rate plus a premium based on anticipated inflation. Of course, depending upon what inflation actually does, the inflation premium can turn out to be accurate; borrowers can benefit when inflation turns out to be higher than anticipated; or lenders benefit when inflation turns out to be less than expected.

Interest rates are very real costs of doing business, and when they are on the rise, whether due to inflation or the Fed trying to kill off inflation, the negatives cannot be ignored, with small businesses naturally suffering most.

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council. His latest book is The Weekly Economist: 52 Quick Reads to Help You Think Like an Economist.