Would a Rise in Interest Rates be Good for Small Business? example

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Would a Rise in Interest Rates be Good for Small Business?



Personal Income

Curbing the Inflation





The monetary policy of the state can be broadly defined as the means and efforts of the regulative bodies relating the supply of money. Government’s policy in this sphere directly affects the aggregate demand or national spending and through it has impact on the real foreign exchange rates, Gross Domestic Product (GDP), real interest rates, unemployment and composition of output (Labonte, Makinen, 2006, p. 2).

Official interest rate of Bank of England is one of the main mechanisms of the monetary policy. It is used to either stimulate or curb the activity in the economy to balance the supply and demand of goods (BoE, n.a., p.1). This equilibrium is important as, in case demand exceeds the supply, the market suffers from deficit that triggers the growth of prices i.e. inflation, and on the contrary, in case supply exceeds the demand, the market suffers from surplus, abundance of goods and overproduction that can cause systematic crises often referred as “vicious circle” (Wicksell, 2007, p. 225). For example, overproduction due to low consumption forces the producers to decrease the level of production thus cut wages, labour hours or even personnel that decreases the level of income of the households overall and leads to even greater decrease of the consumption. So, the government uses the interest rate to keep the supply and demand balanced. Interest rate is also considered to be the “price of money” (Guttmann, 1997, p. 201). Therefore, it effects the availability of resources for all agents of the economy.

The increase of the interest rates will negatively affect small businesses in the United Kingdom. Given the high level of personal debt in the country (ICAEW, 2015, p. 2) the increase in interest rates will significantly decrease the average consumer disposable income thus decrease the consumption. The decrease of the consumption can drive the economy into the abovementioned vicious circle. Small businesses often confront lack of capital or liquidity and increase of the rates will basically mean that the price of the money will rise thus limit the growth of the small business.

Personal Income

Increase in interest rates should stimulate the growth of the real interest rates, thus increase the return on deposits and savings. Keynesian theory claims that this leads to an increase of personal income of the households and increases the demand (Hazlitt, 1959, p. 208). So, basically, small businesses should benefit from the increase of the interest rates as consumers will receive more income and therefore spend more. However, the real outcome depends on the structure of the capital of the households. Once the households rely heavily on debt, the increase in the interest rates will significantly decrease the disposable income of the households and trigger the decrease in the consumption. Given that the levels of personal debt have increased dramatically in the recent years the results of the rates increase might jeopardise the consumer demand which was the main driver of the economy growth …

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