Federal Reserve: The Impact of Raising Interest Rates on Firms

         On September 17th, the Federal Reserve concluded its usual meeting with the announcement that Quantitative Easing (the Federal Reserve's bond buyback program) will continue to wind down and will eventually end after October. What QE did for the broad economy was buy bonds, which in turn pumped money into the economy that led to the reduction in interest rates. The Fed also used other monetary policies (such as holding the Federal Funds rate low), which held interest rates to a historic low.  This allowed banks to extend easy credit to individual firms and consumers. Since the Recession over 6 years ago, the Fed has effectively pumped $4 trillion into the economy (as in purchased $4 trillion in US Treasuries and mortgage bonds). With interest rates at an historic low, this has allowed firms’ access to easy, cheap credit. Now, with the Fed seeking to normalize policy and raise interest rates, this will effectively make it more difficult (costly) for a firm to borrow. Though the Fed announced it would not raise rates until a time still not determined in the future, it is still important to discuss the potential effects of rising interest rates on the individual firm. 

Firms all across the country will be faced with the challenge of expanding their business through credit (usually through loans) or keeping up with their current credit payments if they have a floating interest rate. This will force the firm to weigh the opportunity cost decision of whether to invest its cash with the high interest rates or to pay more for loans to fund new projects. On the other side, the individual will be confronted with a similar dilemma, consume now or consume later. Most likely the consumer would rather invest now rather than buy anything on credit, or alternatively pay for the same products at a higher prices- ie from companies raising prices in response to higher borrowing costs.  

            Interest rates play an important role in the economy by keeping inflation at bay. However, what is the cost of keeping inflation at bay with high interest rates with the economy? That will be seen in coming years. It is a necessary move to raise interest rates because it not only holds inflation down, but it also allows the Fed to regain its firepower to inject stimulus into the economy down the road. But, in the short run it will cause firms to cut back and individuals to consume less.

-Matthew Wilkes