The FED: Monetary Policy & How It Affects Your Business
The Federal Reserve Board referred to as the FED is the central banking system in the US, comprised of a Board of Governors, 6 members and a chair each nominated by the President and confirmed by the Senate.
The Board of Governors, the president of the New York regional bank and four other regional bank members make up the voting members of the Federal Open Market Committee (FOMC) which votes on policy decisions in the Federal Reserve System. In addition to the voting members, the remaining regional bank presidents are members of the FOMC and are essential in making projections during FED meetings.
The principal job of the FED is to guide the economy primarily through raising or lowering interest rates, a baseline or “target” rate of which banks are set to borrow money from each other which in turn directly translates to the loan principal for individuals or business borrowing money.
Essentially the FED, by dictating monetary policy, attempts at safeguarding the economy. During a recession or high inflationary period, the FED steps in to help regulate economic activity to achieve stability. The FED target rate changes often and is determined by numerous factors principally, employment numbers, inflation readings, bond prices, & consumer spending.
The FOMC meets eight times per year and during the meetings, after taking in economic data, deliberate whether the target rate should be raised or lowered which usually occurs on a small scale of 25 basis points unless extreme policy intervention is needed during a recession for example.
How does all of this affect your business? There are countless ways companies are influenced by this overarching monetary policy, there is both a direct and indirect impact.
Interest rates on loans directly taken out from financial institutions whether banks or credit unions have a huge effect on businesses, especially start-ups.
Take the following example: in 2016 the FED target rate was around 1% so the baseline for a loan taken out by individuals or businesses was relatively low. A 10 year $500,000 loan at 1% APR base = $5,000, total loan plus principle at $550,000.
Take an example of the base line interest rate today at 4.5% The same loan at $500,000 at 10 years, would move the APR to $22,500 total loan cost $725,000.
With this in mind, it is essential for businesses to be strategic while seeking financing and pay close attention to the current monetary policy as well as accounting for specific financial institutions to seek financial backing from. Credit Unions, and smaller banks, as an example, tend to offer better lending terms than larger banks.
In regard to the indirect impact on businesses of the FEDs financial policy lies in customers behavior. Higher interest rates make things as a whole more expensive and the main reason the FED raises rates is to curb spending which in turn lowers inflation and preserves the value of the dollar. There is an old and famed saying on Wall St “Don’t fight the FED” in essence, when they are trying to slow the economy by raising rates, it’s not the best time for buying and one should cut earnings expectations on their investments.
The majority of Americans are in some form of debt, they have a mortgage, car loan, or credit card payments, when interest rates go higher those borrowing rates increase, therefore, the average citizen has to spend more and by default has less capital to part ways with when it comes to spending on your business’ products or service.
As rates increase, consumer confidence and spending declines, the FED holds rates until companies react and prices for goods and services in turn drop, inflation lowers as there is less economic activity and once things stabilize they can begin to slowly cut back rates, test the waters, and continue to act accordingly.
This plays into how your business is run, as we all know sales is the life blood of any business, generating revenue is paramount, finding the perfect price point for a product or service and being flexible to adapt to the market conditions that all of us live in is essential for survival especially in today’s tumultuous economy.
The chief way to stay ahead is to keep your hand on the pulse, invest in data and analytics services who can provide insight into where the consumer is spending their money, and the direction the economy is moving. When there are economic constraints and less available discretionary income to be spent the consumer tends to spend in certain markets or for services they deem essential, which change often, seasonally and socially. If you as a business owner can stay a head of the curve as the biggest and most successful do, the lofty dream of longevity most companies have can be yours to keep.
For personalized guidance for your business on this topic and others contact us.
- Vincent Calace
Founder & CEO Venture Business Development