The Federal Reserve's High Interest Rates: Stifling Small Business Growth in 2025

Summary

In summary, the Federal Reserve's decision to not lower interest rates in the first half of 2025 represents a critical regulatory action that raises borrowing costs, restricts credit access, and curbs small businesses' ability to grow. While intended to stabilize the economy, this policy risks stifling innovation, job creation, and grassroots expansion. Policymakers must strike a balance between controlling inflation and supporting the entrepreneurial sector, as prolonged high rates could exacerbate challenges for small firms. Monitoring upcoming FOMC signals will be crucial for any potential pivot that could unlock growth opportunities.

In the economic landscape of 2025, small businesses face significant challenges due to the Federal Reserve’s decision to maintain elevated interest rates. As of July 22, 2025, the federal funds effective rate remains at 4.33%, with the target range held steady at 4.25% to 4.50%. This regulatory stance, aimed at curbing persistent inflation amid uncertainties like tariffs and geopolitical risks, has raised the cost of capital, disproportionately affecting small enterprises that rely heavily on loans for operations, expansion, and hiring. Despite three rate cuts in late 2024 that provided initial relief through lower borrowing costs and updated SBA refinancing rules, the Fed has reversed course, opting to hold rates high throughout much of 2025 to prevent economic overheating.

The Context of the Fed’s Policy

The Federal Reserve’s Open Market Committee (FOMC) has kept interest rates unchanged since just after the 2024 General Election, reflecting concerns that inflation pressures worsen due to Trump’s economic and trade policies. While the June 2025 meeting hinted at possible cuts later in the year, market expectations suggest no immediate reductions at the upcoming July meeting, with potential easing only in September or later. The Fed’s policy continues to focus on post-pandemic inflation, but has drawn criticism for slowing economic momentum. Small businesses, lacking the financial reserves of larger corporations, are particularly vulnerable, as they often depend on bank loans where these rates directly inflate monthly payments and reduce profitability.

Some investors anticipate two rate cuts totaling 0.75 percentage points by December 2025, which could lower the prime rate to 3.75-4.00%. However, the Fed will consider factors such as supply chain issues and labor market conditions before deciding on cuts, which may delay this decision. In the meantime, average small-business bank loan interest rates have ranged from 6.6% to 11.5% in the first half of 2025. The SBA 7(a) loan rates ranged between 10.5% and 15.5%. The average loan amount for small businesses was $83,348 (Federal Reserve Bank of Kansas City’s Small Business Lending Survey), while the average SBA 7(a) loan amount was $439,339.deterring borrowing even as opportunities arise.

The Impact of a 1% Rate Reduction

A 1% interest rate decrease has a significant impact on the total interest paid over the life of small business loans in the first half of 2025. For the average general small business loan of $83,348 with a 5-year term, reducing the interest rate from 9% to 8% results in savings of approximately $2,618.40. For the average SBA 7(a) loan of $439,339 with a 7-year term, lowering the rate from 13% to 12% yields savings of about $20,047.44. These calculations, based on fixed-rate loan amortization, highlight the substantial financial benefit of even a modest rate reduction, particularly for larger loans with longer terms, assuming no early repayment or additional fees.

Analyzing the Impact on Small Businesses

As the example illustrates, the Federal Reserve’s reluctance to lower rates increases borrowing costs, creating barriers to economic growth. The increased cost of borrowing, both for the nation (national debt) and the business sector, can potentially crowd out infrastructure investment, raise the cost of capital for expansion, capital equipment purchases, and hiring. The rising cost of living and borrowing can dampen consumer spending, shrink demand for small business goods and services, and compound the increasing costs of labor (minimum wage increases).

For all of us, especially small businesses, every dollar counts. Let’s look at the effects through several interconnected mechanisms:

Increased Borrowing Costs

By holding the benchmark rate high, the Fed influences banks to charge more for loans, tightening lending criteria and making it harder for startups or firms with limited financial histories to secure funding. This results in higher monthly payments on variable-rate loans, reduced loan sizes—evidenced by a 38% decline in average SBA loan amounts from May 2021 to May 2025—and an elevated risk of default for businesses carrying debt. Sectors such as retail and construction, which are reliant on project financing, have experienced particular slowdowns in their expansion plans.

Reduced Expansion and Hiring

Higher costs constrain cash flow, forcing small businesses to delay investments in equipment, technology, or marketing, and postpone hiring new staff. This conservative approach prioritizes survival over growth, placing small firms at a disadvantage compared to larger competitors with internal funds or access to the bond market. Surveys indicate widespread hesitation, with loan approvals dipping and owners reporting uncertainty around delayed rate cuts.

Dampened Consumer Spending Power

Elevated rates extend to consumer credit, resulting in shrinking disposable income and reduced spending at local businesses. This demand-side pressure compounds operational challenges, particularly for consumer-facing sectors, leading to lower revenue and further limiting growth potential.

Inflation Control vs. Growth Trade-off

The Fed’s primary goal is price stability, which involves restricting the money supply to prevent inflation; however, this approach comes at the expense of affordable credit for small businesses operating on thin margins. While a “healthy” economy justifies the stance, it creates a vicious cycle: reduced investment slows overall growth, reinforcing the need for caution.

Quantitatively, these effects are evident in declining small business loan approvals and sentiment surveys, where high interest rates deter borrowing despite available opportunities.

Potential Pathways Forward and Alternatives

To navigate this environment, small businesses can explore alternatives such as SBA loans with flexible terms, refinancing existing debt, or reducing costs to manage payments. Choosing fixed-rate loans mitigates risks in a high-rate period, while maintaining strong financials improves lender appeal. Advocates argue that timely rate cuts could spur lending without reigniting inflation, especially with fiscal measures, but ultimate relief hinges on FOMC decisions amid ongoing tariff concerns.

Conclusion

To outgrow inflation, both the nation and individual businesses must prioritize strategies that enhance productivity, innovation, and economic resilience. Nationally, fostering policies that promote investment in technology, infrastructure, and workforce development can boost economic output, increasing real GDP growth to outpace inflation rates, which hovered around 2-3% in early 2025. For individual businesses, particularly small ones, outgrowing inflation involves optimizing operations to reduce costs—such as adopting automation—and diversifying revenue streams to mitigate price pressures. Businesses can also invest in employee training to improve efficiency and focus on high-value products or services that maintain pricing power. By aligning with emerging market trends and leveraging digital tools, businesses can achieve revenue growth that exceeds inflation, while national policies that stabilize borrowing costs (e.g., through prudent monetary policy following the FOMC’s 2024 rate adjustments) create a supportive environment for sustained economic expansion.

In summary, the Federal Reserve’s decision to not lower interest rates in the first half of 2025 represents a critical regulatory action that raises borrowing costs, restricts credit access, and curbs small businesses’ ability to grow. While intended to stabilize the economy, this policy risks stifling innovation, job creation, and grassroots expansion. Policymakers must strike a balance between controlling inflation and supporting the entrepreneurial sector, as prolonged high rates could exacerbate challenges for small firms. Monitoring upcoming FOMC signals will be crucial for any potential pivot that could unlock growth opportunities.

References:

The Federal Reserve’s High Interest Rates: Stifling Small Business Growth in 2025