Question

How can changes in the federal reserve policy affect a small business?

Answer 1

Federal Reserve manages US monetary policy by controlling the level of short term interest rates in the economy. Now, interest rates have a huge impact on economic activity in the following ways:

• Household consumption: Consumption is a major driver of any economy. As people consume more, businesses earn more. For example, when interest rates are low in the economy, people have a higher incentive to buy that car or Television set because it is cheaper to finance them. This gives a major boost to small businesses. On the other hand, when interest rates are high, people are reluctant to spend which in turn is bad for the small businesses.
• Business Investment: Businesses need credit all the time. It may be for working capital needs or for that next retail store or a delivery truck (investment basically). When interest rates are lower, it is cheaper for businesses to raise credit that is so essential for them to grow.
• Inflation: Now, low interest rates are not all good. When interest rates are low, they give rise to inflation. Inflation is when the prices of goods in the economy is going up. This is primarily because of the increased consumption. As more people demand the same amount of goods, prices go up. Now, inflation is bad for the whole economy including small businesses. Imagine having to change price tags on you products ever so often or your workers constantly negotiating for higher salaries as cost of living goes up.

So, this is how Federal Reserve policy can have a major impact on the economy, small businesses included.