The Effect of Changes in Monetary Policy on the Expectations, 

Spending, and Hiring Decisions of Small Business Owners

 William C. Dunkelberg and Jonathan A. Scott

2005. [42] pages. Voorhees, N.J. 08043

This report was developed under a contract with the Small Business Administration, Office of Advocacy, and contains information and 

analysis that was reviewed and edited by officials of the Office of Advocacy. However, the final conclusions of the report do not necessarily reflect the views of the Office of Advocacy.

The transmission channels through which changes in 

monetary policy affect private sector spending and 

hiring are incompletely understood, especially in the 

small business sector. This sector is responsible for 

most of the job growth and innovation in the U.S. 

economy and half of the private sector GDP production. Despite the importance of this sector’s contribution to real economic activity, many small firms are 

not closely tied to the capital markets.

This study documents how small firms react to 

unexpected changes in monetary policy. Monthly 

survey data obtained from the National Federation of 

Independent Business illustrate how owner expectations are affected by these changes, with corresponding adjustments to spending and hiring plans, and 

ultimately changes in actual spending and hiring. 

Thus, the results provide some new micro level 

insight into how quickly changes in monetary policy 

work through the small business sector and ultimately the aggregate real economy.

This analysis is unique among studies of the transmission channels of monetary policy in two ways. 

First, the data include small firm expectations for 

both the economy as it affects general business conditions and their own sales as well as for spending 

and hiring plans. Two of the surveys are bifurcated 

on the date of a surprise policy announcement, thus 

permitting a more precise examination of how the 

policy change affected expectations and plans of 

small firm owners. Second, the disaggregated data 

allow a comparison of the reaction of interest-sensitive sectors such as construction and manufacturing 

to less sensitive sectors such as non-professional services or retailing to monetary policy changes.

Overall Findings

The findings indicate that the small business sector 

responds immediately to announced changes in monetary policy and that these changes have significant 

impacts on employment and prices, the two major 

concerns of monetary policy.

Highlights

• Small business owners respond within two 

weeks of unexpected changes in monetary policy 

announced by the Federal Reserve Board. As measured by the percent of firms responding positively 

to a group of questions about expectations and 

spending plans, the changes were significant.

• Owners with no exposure to interest rates and 

borrowing costs respond in much the same way as 

interest-sensitive borrowers.

• These changes produced are associated with significant changes in the inflation and unemployment 

rates in the month after the announcement.

• The responses to changes in monetary policy differ substantially by industry groups.

• The spending responses do not conform to the 

simple predictions of capital market models of the 

response to monetary policy (e.g. lower rates do 

not always produce positive spending and hiring 

responses).

• Firm owners clearly interpret Federal Reserve 

Board actions in the context of other information about the economy and their local markets. A 

rational expectations model appears to describe the 

responses of owners better, but this model cannot be 

used to predict systematically the responses of owners to policy changes.

November 2005 No. 267
Methodology

The analysis relies on the monthly surveys conducted by the National Federation of Independent 

Business of their members. These surveys ask about 

the owner’s outlook for the economy and overall 

business environment, company plans for hiring, 

capital spending, inventory investment, worker compensation and selling prices. Two of the surveys were 

bifurcated in April and September 2001 when the 

Federal Reserve Board announced surprise changes 

in monetary policy, with unexpected inter-meeting 

declines in the target Fed funds rate. In addition, the 

response of owners to an unexpected increase in the 

target Fed funds rate in April 1994 was examined as 

well. The former changes with the bifurcated samples allow a more precise assessment of how owner 

expectations and plans change.

The mean responses to the questions are computed before and after the policy change for April 

and September 2001. Significance is assessed by 

examining the sampling error between the two periods. Tests are conducted to ensure that the responses 

received before the policy change and after are statistically independent.

Assessment of the effect of policy changes on 

actual hiring and spending plans are more difficult 

to assess because of the effect of other economic 

events taking place during that time. An alternative 

approach is used that incorporates the post-policy 

change responses to hiring plans and planned price 

changes into previously estimated equations that 

related these variables to the unemployment rate and 

CPI inflation.

The responses are also disaggregated by industry 

for construction, manufacturing, retailing and nonprofessional services. The smaller sample sizes made 

it more difficult to assess the significance of changes, 

but non-parametric tests still provide evidence of 

important negative effects on expectations and plans 

for the construction industry.

For the April 1994 policy change there is no bifurcated sample but it was a surprise increase instead 

of a surprise decrease as was the case in April and 

September 2001. While significant changes were 

identified comparing May versus March responses, 

they could have been attributable to seasonal factors. 

After seasonally adjusting the responses, none of the 

signs of the changes are affected, although the significance changes for a few of the variables.

This report was peer reviewed consistent with 

Advocacy’s data quality guidelines. More information on this process can be obtained by contacting the 

director of economic research at advocacy@sba.gov

or (202) 205-6533.

Ordering Information

The full text of this report and summaries of other 

studies performed under contract with the U.S. Small 

Business Administration’s Office of Advocacy are 

available on the Internet at www.sba.gov/advo/research. 

Copies are available for purchase from:

National Technical Information Service

5285 Port Royal Road

Springfield, VA 22161

(800) 553-6847 or (703) 605-6000

TDD: (703) 487-4639

www.ntis.gov

Order number: PB2006-100579

To receive email notices of new Advocacy research, 

press releases, regulatory communications, and publications, including the latest issue of The Small Business 

Advocate newsletter, visit http://web.sba.gov/list and 

subscribe to the appropriate Listserv.