Rising interest rates and surging inflation: What it means to business owners?

Entrepreneurs, businesses, workers, and investors have every incentive to solve problems related to supply chains and labor shortages. There are things that we know about inflation and its effects that must be kept in mind.

Raymond J. Keating

Ironically, uncertainty seems to have become a certainty for small business owners over the last few years. 

Consider the list:  A deadly pandemic struck. Then came government shutdowns to contain the pandemic’s spread. That was followed by a re-opening and recovery plagued by supply chain problems along with tight labor markets. And if that wasn’t enough, inflation has reared its ugly head in a serious way for the first time in four decades.

Indeed, it’s actually even worse than that. The latest economic growth data at the time of this writing showed that real GDP declined by 1.6 percent in the first quarter of 2022 and expectations widely point to a recession arriving at some point within the coming 12 months. At the same time, inflation rages, and expectations among small business owners, for example, is that inflation will continue to run hot. Slow growth or a recession combined with high inflation (i.e., an ongoing increase in the general price level), well, that’s stagflation. And again, the last time we had a dire bout of stagflation was in the 1970s into the very early 1980s.  

Given this barrage of uncertainties, it’s understandable that entrepreneurs and investors might be asking: What does all of this mean for what we’re trying to do and accomplish?

Well, even amidst all of this uncertainty, there are at least some things we know.

First, entrepreneurs, businesses, workers, and investors have every incentive to solve problems related to supply chains and labor shortages. The free enterprise system provides the incentives to guide resources to productive undertakings via price and profit signals. And while some of us might be surprised at how long it’s taking to get back to something close to normal, we’re moving in the right direction.

Second, at the same time, inflation is wreaking havoc on consumers and on businesses of all types and sizes. Again, amidst uncertainty, there are things that we know about inflation and its effects that must be kept in mind. 

Inflation quite simply is the reduction in the dollar’s purchasing power, that is, a dollar tomorrow will be worth less than today. Therefore, inflation eats away at incomes, savings, and investment, which is why inflation often is referred to as a kind of tax. 

Inflation itself inflicts additional uncertainty – there’s that certainty about uncertainty thing again – about where prices and interest rates are headed, making it hard for entrepreneurs, businesses, and investors to plan. Yes, we know that prices and interest rates will rise, but by how much and the amount of volatility are hard to estimate. Obviously, costs increase for businesses of all types and sizes, and business owners again are left trying to deal with rising input costs while trying to figure out how to price their own goods and services so as to not suffer a devastating loss of business. 

Besides being a kind of tax itself, inflation increases actual taxes, for example, since capital gains are not indexed for inflation, it turns out the real capital gains tax is much higher than the stated, nominal rate – and the higher the inflation rate, the higher the real capital gains tax. That diminishes the potential returns on, and therefore discourages, entrepreneurship and investment.

Third, we should have learned from the 1980s that the remedy for stagflation is establishing a sound policy foundation for economic growth to flourish. That means advancing policies such as tax and regulatory relief and free trade, while monetary authorities focus on price stability. If one keeps in mind that inflation is about too much money chasing too few goods, then this policy combination makes sense.

And there’s actually one more thing that we can be certain about, that is, entrepreneurs, businesses, and their employees will be working hard to counter the ills of inflation as best they can via, for example, investments in innovation and efficiencies. In the end, no one profits or benefits from stagflation.