The process of globalization has made markets across the globe increasingly connected. That’s why all businesses should follow economic conditions not only for the market they operate in but also for the global economy. Low interest rates are becoming one of the preferred monetary policies for many governments. Their main roles are to help manage inflation levels, fight supply chain disruptions, and not allow the economy to go into a recession. Nevertheless, the effects of low interest rates on businesses can be negative too. In this article, we’ll share more about the advantages and disadvantages of low interest rates. This article is part of our series on different market states. Check out our posts on the impact of inflation on businesses, what businesses flourish in recession, or how to deal with inflation in a business.
What Are Low Interest Rates
The phrase low interest rate means that the current interest paid by borrowers is lower compared to historical averages. Central banks (like the Fed) use low interest rates as a way to stimulate borrowing and economic activity. They are a powerful instrument that can jump-start the economy after a period of recession or deflation.
The effects of low interest rates on businesses can differ. They help companies that wish to invest in technology or other improvements aimed to lower operating expenses. On the other hand, companies with conservative fiscal practices might not be able to benefit from low borrowing rates and struggle to adapt to the changing market conditions.
Acquiring debt is stimulated during periods of low interest rates. However, companies should use business analytics tools and calculators to plan scenarios if the central bank decides to increase the target interest rate.
Key takeaway: Low interest rates make borrowing easier and give businesses easier access to lines of credit. This monetary policy is used by central banks to stimulate spending and help economic growth.
Advantages and Positive Effects of Low Interest Rates on Businesses
Generally speaking, low interest rates have more positive than negative effects on the economy. So, it’s no wonder that they are a preferred monetary policy for many central banks. The Fed and other central banks will start increasing interest rates only if they see signs that the economy is overheating and inflation is rising. Let’s see what are the main positive effects of low interest rates on businesses.
Companies that have borrowed money from lending institutions might see their interest costs decrease if central banks lower interest rates. Obtaining loans and credit lines at more favorable terms gives businesses the opportunity to invest in expansions or other capital projects. One of the effects of low interest rates on businesses and the market is that a lot of new jobs are created.
As borrowing costs are decreased businesses are stimulated to invest in technology and innovation. Otherwise, they can fall behind their competitors and lose market share.
During a period of low interest rates, both retail and wholesale prices are on the rise. The reason for this is that buying and spending are stimulated by the cheap cost of money. These situations can be very beneficial for businesses that have optimized their processes and lowered their production costs. The increase in prices can mean that companies will have a higher ROI which can be reinvested in expansion or strategic acquisition of other businesses.
Market Stability and Currency Depreciation
Among the effects of low interest rates on businesses is easier access to capital for investors. This makes it more attractive to buy stocks or other assets. Ergo, public companies can expect their stock price to increase.
In addition to market stimulation, another effect of low interest rates on businesses and the economy is that currency loses its value. That might have negative impacts but it can be profitable for export-oriented companies. As currency loses its value, this makes exported products more competitive in international markets.
Cons and Negative Effects of Low Interest Rates on Businesses
Although there are numerous positive effects of low interest rates on businesses and the market, they can create problems as well. That’s why central banks carefully monitor metrics such as employment and inflation in order to set the interest rates to optimal levels. Let’s check some of the main negative effects of low interest rates on businesses.
Reduced Interest on Savings
Households and businesses often hold cash on hand. If the interest rates are low, that means depositors will get little or no interest on their savings.
Intensified Market Dynamics
One of the effects of high interest rates on businesses is that they slow down market activity. That can give time for businesses to reorganize their structure or improve business processes. However, during a period with low interest rates, companies are incentivized to be more aggressive with their investments. This creates intense competition and can result in struggles for companies that are more fiscally conservative.
Asset Bubbles and Bad Investments
Low interest rates can inflate the prices of certain assets like real estate or stocks. This can lead to bad investments for businesses.
Incentive for Risk-Taking
As lines of credit become more attractive, companies aim to maximize profits and are encouraged to take more risks. This can lead to fiscal instability as interest rates will eventually rise.
Frequently Asked Questions about the Effects of Low Interest Rates on Businesses
The market is constantly changing. Companies need to adapt to the new realities. Below we have listed some of the commonly asked questions on the topic of low interest rates. They might help you navigate through the challenges of today’s economy.
Why Central Banks Decrease Interest Rates?
The main reason why central banks lower interest rates is to stimulate the economy. By lowering borrowing costs, businesses can easily get access to the cash needed for investments or technology integrations. Furthermore, low interest rates also stimulate household spending. As consumers are incentivized to buy more things, businesses can maximize revenue and business owners can create new jobs.
What Are Negative Interest Rates?
Negative interest rates can be an extreme monetary policy to mitigate the effects of economic stagnation. If a central bank sets interest rates below zero, this means they are trying to stimulate spending and economic growth to affect businesses positively. The negative interest rate policy (NIRP) is fairly new in monetary theory. There are very few countries that have tried this policy. Even though it can sound beneficial in theory, negative interest rates can create asset bubbles as the market doesn’t know the real cost of money. That’s why central banks will often increase interest rates after they have battled deflation in businesses and the economy. If central banks keep their interest rates negative, they risk experiencing the effects of inflation.
Is the Lowest Interest Rate the Best?
When choosing a line of credit, companies and individuals should not automatically opt for the lowest interest rates on the market. Banks and other institutions will often use lower interest rates as a marketing strategy and profit from additional taxes. Therefore, comparing the annual percentage rate (APR) is far more important when borrowing money. This metric includes the interest rate and all additional costs and fees.