Impact of Tight Money and/or Recessions on Small Business

The opinions and recommendations of the authors of this study do not necessarily reflect official positions of the SBA or other agencies of the U.S. government. Executive Summary The long expansion, two recessions, and financial disruptions affected businesses of all sizes over the past dozen years. Small businesses may be particularly exposed to recessions, banking conditions, and monetary policy. The kinds of goods and services that small businesses produce may be either more or less vulnerable to economic recessions or expansions. Small businesses typically rely more for their credit on bank lending than larger firms do. As a consequence, smaller businesses may be more adversely affected when tighter monetary policies or deteriorating bank health reduce the supply of bank loans. This study investigated how much and how differently small businesses were affected by banking conditions, by interest rates, and by local growth rates. We used annual, state-level data for 1990-2000 to answer the following questions: • Do economic slowdowns, tighter monetary policy, or adverse conditions in banking sector affect small businesses more than larger businesses? • During tight monetary periods or economic slowdowns, what are the effects on real economic activity at smaller businesses and in the overall economy of small, medium, and large-size bank capital and SBA-guaranteed loan programs? • How much are various effects changed during economic slowdowns or when interest rates are high? Tighter monetary policy and adverse conditions in banking reduced bank lending, economic growth, employment, and payrolls at businesses of all sizes. We also found that adverse conditions at small banks impinged more on small than on large businesses. For example, declining capital and rising loan delinquencies at small banks affected business failure and bankruptcy rates considerably more than adverse conditions at larger banks. Some evidence indicated that SBA-guaranteed loans raised economic growth rates, employment, wages and salaries, and nonfarm proprietors' incomes. SBA-guaranteed loans were less pro-cyclical and more immune to capital pressures at banks than were non-guaranteed loans. As a result, SBA programs may have acted as an economic stabilizer. During periods of slow growth or of tight monetary policy, small businesses tended to respond considerably more to changes in bank capital, loan delinquencies, and SBA-guaranteed loans. The larger responses suggest that ameliorating policies might be significantly more 3 effective during periods of economic or monetary stress than would be suggested by their average effects.