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Never Fear the Mystery of the Fluctuating Interest Rate

January 1, 1999
Related Topics: Finance/Taxes, Featured Article
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One of the mysteries of life in the United States today is when the Federal Reserve Board will next raise or lower interest rates. Economists find it as difficult to forecast as the weather. It’s like watching mercury in a thermometer move up and down, day after day, year after year. There’s not much you can do but sit there and watch, prepare for the worst and hope for the best.

Given how important interest rates are to the economy, businesspeople every day struggle to make sense of it all. One quarter-point change up or down can lift a company’s spirits sky-high or send them spiraling into a bottomless depression. This may be a slight exaggeration, but it’s undeniable that change is an expected characteristic of the economic environment in which U.S. companies operate, and financing your company is getting more complicated all the time.

Low interest rates lift economy.
According to conventional theory, rising interest rates increase the cost of borrowing money, and thus cause a drop in investment because it becomes too expensive to borrow money—money that could be used to expand plants, finance research, acquire firms and produce goods and services.

Lately, though, the economy has been getting a boost from relatively low and stable interest rates. Cheaper loans are good news if you’re investing in new projects, borrowing to make long-term investments to accommodate growth, and giving workers annual raises.

"Oftentimes, companies have to rely on loans to continue doing business," says John Wachowicz, co-author of Fundamentals of Financial Management (Prentice-Hall, 1998). "A low-interest rate environment makes it easier for businesses to raise capital, which means it’s a great time to conduct business."

Projects that weren’t feasible when interest rates were high are reasonable in a low-interest rate environment. More or less, this means most people have jobs.

This type of labor market makes it tough for companies to hire experienced workers. The unemployment rate is lower than it has been in years. Companies are struggling to find people, and they’re having to offer additional incentives over what they’re accustomed to offering to get the same quality of worker. Things could be worse. But don’t think for a moment that the current low-interest rate environment will last forever.

It’s time to think ahead.
Of course, most businesspeople would rather operate in a low-interest rate environment than the alternative. But let’s not forget the interest rate spike that moved the prime from 11 percent in late 1980 to 21.5 percent in 1981. Some companies are starting to think about how high interest rates in the future might sting.

"Many companies are taking this opportunity to adjust their capital restructure," says James W. Wansley, head of the financial department at the University of Tennessee in Knoxville. "Everyone knows debt is less expensive than before, and the interest companies pay for debt is tax deductible. Companies should use this time to clean up their balance sheets."

This isn’t an entirely new notion, but no one knows for sure when the Federal Reserve Board will jerk the interest rate’s levers. The worst mistake any company owner or manager could commit would be to pay no attention to the warning signs. Better to monitor worldwide economics and political trends than to ignore everything and be caught unprepared.

It’s easy enough to get carried away with a booming economy and low interest rates. But maybe it’s just a matter of time before interest rates make a significant move in the other direction. Clearly, it’s dangerous to assume that interest rates will stay at their current level, which means it’s best to take precautions now when borrowing money because even economists can’t see the smudges on the economic horizon.

Workforce, January 1999, Vol. 78, No. 1, p. 111.

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