Things every indie hacker should know about monetary economics

Do your eyes glaze over when someone mentions interest rates or the Fed?

If so, you're not alone. Tons of indie hackers are too busy building and shipping to dive into economics. But understanding the economy doesn't have to be hard.

Below we've written a very simple explainer of the basics that anyone can understand: no jargon, no judgment, just the essentials that will help you make smarter business decisions.

Let's start with why credit is important.

The economy may seem complicated, but at its heart, it's just a massive collection of transactions. Every time someone buys your SaaS product, and every time you pay a freelancer, money flows from one person to another. These transactions happen through two main channels:

• Cash: Spending money you already have.

• Credit: Spending money you don't have, that you're borrowing from someone else, while promising to them pay back later.

Credit is important, because when businesses can easily borrow money, they don't have to wait until they have all the cash needed for growth, so they can grow faster. They can immediately hire people, buy equipment, and expand now. The same is true for consumers. When consumers can easily borrow money, they can immediately buy houses, buy vehicles, and start businesses.

All of this spending creates transactions, which, as we said earlier, are what make up the economy. The recipients of this spending—the employees, homeowners, businesses, etc. being paid—can now spend their their newly earned money on things they want and need. In other words, there are even more transactions and payments.

This ripple effect is why easily available credit acts as a multiplier on the economy. Credit makes the economy move.

As an example, consider buying a house:

1. Most people can't afford to save up the full price of the home they want, so they take out a mortgage, which is just credit for buying a house.

2. Without this credit, they'd have to rent for decades while saving up.

3. As a result, construction companies would have fewer houses to build, so they would employ fewer workers and buy fewer construction materials.

4. Construction material companies would therefore have fewer customers to sell to, so they'd make less money, so they'd spend less money hiring employees, paying accountants, and buying tools of their own.

5. And so on and so forth.

Just this one type of credit unlocks an entire chain of economic activity that would suffer without it.

Since credit is so important, interest rates are important, too.

Just like goods and services have a cost, credit also has a cost. When people and businesses borrow money, they have to pay interest. Think of interest as the price tag for credit.

Interest rates are simple to understand. For example, if you borrow $100,000 at a 5% annual interest rate, then after one year, you owe the $100K you borrowed plus an extra $5,000 (5% of the $100K) to cover the interest.

The lower interest rates are across the economy, the cheaper it is for everyone to borrow money. And the cheaper it is for everyone to borrow money, the more money they borrow. As we saw earlier, more borrowing leads to more spending and thus more economic activity for people, employees, and businesses.

So low interest rates and lots of credit are often seen as a good thing that gets the economy moving, whereas high interest rates mean less borrowing and a slower-moving economy.

But where do interest rates come from, and what causes them to rise and fall?

Interest rates are controlled by the Fed, so the Fed is important.

People and businesses typically borrow money from banks, so the banks charge interest rates, which allows them to profit from the money they lend.

But banks themselves also borrow money—often from each other or from a "central bank." Unlike regular banks that serve people and businesses, a central bank serves the entire banking system. In the U.S., the central bank is the Federal Reserve, or the Fed for short.

Just like the rest of us, banks that borrow money also have to pay interest, and that interest rate is set by the Fed.

About eight times per year, policymakers from the Fed get together, analyze economic data, and decide whether to raise, lower, or maintain the interest rate, also known as the Federal Funds Rate.

You tend to hear a lot buzz about the Fed raising or lowering rates in the news. There's even a lot of speculation about what the Fed might do. It's extremely important to people, because the rate set by the Fed causes a ripple effect.

For example, when the Fed raises interest rates, it's more expensive for banks to borrow money. So banks raise their interest rates for everyone who borrows from them, and it becomes more expensive for everyone to borrow money. This affects spending decisions throughout the entire economy. It's common for rate hikes to hurt stock prices because if borrowing is more expensive, that eats into the profits of most companies.

But why would the Fed ever choose to raise interest rates?

The Fed makes decisions based on inflation, so understanding inflation is important.

The economy is a little bit like a thermostat. As we've seen, if there's too little economic activity, it can get "too cold." When people and businesses aren't borrowing as much, they aren't spending as much. That means businesses aren't earning or hiring as much, so fewer people are employed.

But it's also possible for the economy to get too hot. Imagine an economy with tons of activity:

1. Lots of economic activity means a lot of spending. For example, people buy more clothing, companies hire more employees, etc.

2. The more companies hire, the more competitive it is to hire good employees—imagine lots of fishermen all fishing in the same spot.

3. So companies offer higher salaries to compete and attract employees. As a result, people get paid more.

4. The more people get paid, the more they tend to spend. So sellers start to see a lot of demand for their cars, clothing, food, etc.

5. When sellers struggle to keep up with demand, they hire more people to produce more goods, and the loop repeats. But they also tend to raise prices. This is known as inflation—the general increase in the cost of goods and services.

So a hotter economy means more spending, and more spending means things get more expensive.

Inflation is normal and generally expected. It's a sign of a growing economy. But if inflation happens too fast, it can grow faster than wages grow, and outstrip people's ability to pay for things. That's how things can get too hot.

The Fed, being a government agency, is mandated to do what's good for the country. It doesn't want the economy to get too hot and cause runaway inflation, nor does it want the economy to get too cold and cause high unemployment. So when the policymakers at the Fed get together and decide whether or not to raise rates, they consider factors like recent unemployment and inflation rates:

1. When the economy seems too hot, the Fed will often raise rates to slow down borrowing, and thus slow down spending, and cool off the economy.

2. When the economy seems too cold, the Fed will often lower rates to encourage borrowing, encourage spending, and lead to more hiring.

Inflation is the steady rise in prices over time. That $5 latte you bought last year might cost $6 this year. For indie hackers, inflation affects both sides of your business:

• Your costs go up (hosting, salaries, marketing).

• Your customers' budgets get squeezed.

You can actually use this information in your own business.

Generally, interest rates below 3% are considered low, while rates above 5% are considered high. Websites like the Federal Reserve’s FRED database, Bloomberg, or even just a quick Google search can help you track trends in inflation and interest rates.

When interest rates are low, it's a prime opportunity to grow your business.

• Low rates make borrowing cheaper, which is why companies like Stripe and others went on massive hiring sprees in 2020-2021.

• Access to affordable capital allows businesses to scale faster without significantly increasing costs.

• If you're considering expanding, refinancing debt, or taking out a loan, low-interest periods can be a great time to make those moves.

On the flip side, when interest rates are high (like they are now), it's a good time to focus on efficiency and stability.

• High rates make borrowing more expensive for everyone, which is why you see more layoffs and budget reductions in high interest rate periods.

• Even if you're not directly effected because you aren't planning to borrow money, your customers (and their customers… and their customers) will very possibly have less money to spend.

We hope this was helpful!

Economics doesn’t have to be intimidating, and it’s more relevant to your startup than you might think.

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