Not everyone is a debtor, hoping for lower interest rates on loans. The flip side is that there is no loan without a lender, someone collecting the interest rate revenue. U.S. Treasury Bonds are loans to the government and are held as assets in individual investment portfolios. Banks lend out their depositors’ money and share the interest revenue from the loans with their depositors. Most small business loans are made by commercial banks; many are small, community banks.
In general, interest rates are set by financial markets, not by the Federal Reserve, whose job it is to enforce financial regulations and maintain orderly financial markets. The Fed does set its policy rate, which specifies how much it will pay on excess reserves that are deposited by banks at the Fed and not otherwise loaned out. The higher this rate, the more inclined banks are to keep safe reserves at the Fed rather than make a more risky loan to a real business that will put the funds to work.
Every month, NFIB surveys a random sample of its small business members. The average interest rate reported on their most recent loan over the past 50 years is shown in Chart 1. The graph illustrates the damaging effects of inflation. Owners paid nearly 20% interest (which means the projects financed must have earned far higher rates of return) in the 1980s, and as little as 4% in 2020. Owners are active searchers for favorable loan terms when they need a loan and, when interest rates are changing, look for opportunities to refinance with more favorable terms. More than half of all small firms use at least two financial institutions for their financial services (Bank Competition, NFIB, 2005). Mortgage interest rates are very sensitive to Fed policy because mortgages are very long-term loans, and Chart 1 shows how volatile interest rates can be over time.
Average Rate Paid on Short-Term Loans. NFIB Small Business Economic Trends.
NFIB
When asked to identify their most important business problem from a list of nine issues (Chart 2), 26% of owners selected labor costs, followed closely by government regulations and red tape, chosen by 22%. Taxes ranked third with 14%, followed by insurance cost and availability, with 11% of the votes. Inflation and labor quality tied at 9%.
Single Most Important Problem for Finance Firms. NFIB Small Business Economic Trends.
NFIB
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By industry, firms in agriculture and retail sales most frequently identified finance and interest rates as their single most important problem (just 6% and 5% respectively), a tribute to the financial industry because all firms must finance their operations, and apparently the markets do a pretty good job of providing the needed financial services.
Single Most Important Problem – Financing & Interest Rates. NFIB Small Business Economic Trends.
NFIB
Currently, the Fed is under fire from all sides due to its “dual mandate” (Congress told the Fed to maintain maximum employment and stable prices at the Fed’s annual 2% inflation target, requiring contradictory policies at times). Achieving full employment is best as a responsibility of fiscal policy, while inflation is the province of monetary policy. Low inflation brings low interest rates. The Fed has a tough job at times, and now is one of those times, making sure they achieve both sides of their mandate.