The Economy Explained: America’s Small-Business Economy in Transition

At a glance:

• The economy is in transition, with fundamentals strong but sentiment weak. The nation’s overall economy is growing at a robust 3.8% pace in 2025, and consumer spending remains healthy at 5.6% annual growth. However, small business hiring turned negative in October for the first time since January, and consumer sentiment has fallen to its lowest level of the year. This contrast between solid economic fundamentals and weakening confidence signals a pivotal moment for America’s small businesses.

• Inflation is moderating and the Fed is cutting rates. Inflation has stabilized around 3% – still above the Fed’s 2% target but well below the 9% peak of 2022. More importantly, the Federal Reserve has begun cutting interest rates, with two consecutive cuts bringing rates down from 5.33% to 4.09% by October. This shift in monetary policy should provide relief to small businesses in coming months.

• Business loan rates are finally declining. After two years of painfully high borrowing costs, business loan rates have started to ease. Term loans fell to 7.2-7.8% by mid-2025, down from their 2024 peaks. While still elevated compared to pre-pandemic levels, the direction of travel is finally favorable for small businesses that need to finance growth.

• Compensation costs are growing at a sustainable 4% pace. The dramatic wage escalation of 2022-2023 is behind us. Total employer costs for wages and benefits are growing at a manageable 4% annually – enough to keep pace with inflation while remaining predictable for budgeting. This normalization of labor cost growth removes a major source of uncertainty for small business financial planning.

• Position for a rebound as monetary policy shifts. With the Fed pivoting to rate cuts and economic fundamentals remaining solid, the outlook for 2026 is cautiously optimistic. Small businesses should focus on maintaining financial flexibility, investing in customer relationships, and being ready to capitalize on improving conditions as lower rates work their way through the economy.

Introduction

Small businesses in America today face a paradox. On paper, the economy looks strong: GDP is growing at nearly 4%, consumer spending is healthy, and inflation is moderating. Yet business owners are seeing something different on the ground – weakening demand, falling consumer confidence, and a labor market that has cooled dramatically from its red-hot pace of recent years.

This disconnect reflects an economy in transition. After the Federal Reserve’s aggressive campaign to tame inflation through rapid interest rate hikes in 2022 and 2023, we’re now seeing the lag effects work through the system. Consumers remain cautious despite solid employment. Businesses are hesitant to hire despite healthy revenue growth. And while tariff uncertainty has created additional headwinds, the economy’s fundamentals remain sound.

The good news? The Fed has recognized this transition and begun cutting rates – two cuts in the past two meetings signal a shift in monetary policy that should provide tailwinds for small businesses heading into 2026. The key for business owners and their advisors is understanding this transitional moment and positioning accordingly.

In this article, I’ll walk through an economist’s view of what’s happening in the U.S. economy today, break down the key data points that matter for small businesses, and translate it all into practical strategic guidance. Our goal is to help you see past the headlines to the underlying patterns – and to help you make smart decisions in this pivotal period.

The big picture

GDP growth remains healthy

Let’s start with the most fundamental measure of economic health: Growth in the nation’s gross domestic product (GDP). As of the second quarter of 2025, real GDP grew at an annualized rate of 3.8% – a robust pace by historical standards. This strong growth reflects an economy that continues to expand despite the headwinds of higher interest rates and global trade uncertainty.

To put this in context, 3.8% real GDP growth is well above the long-term average – in the decades since World War II, real U.S. GDP growth has averaged about 3.2%. This means that the fundamental capacity of the U.S. economy, about 70% of which is consumer spending which directly impacts the bottom line for small businesses, remains strong. Consumer demand overall is solid, business investment is steady, and America’s overall economic engine is humming along today.

However, GDP is a backward-looking indicator – it tells us where we’ve been, not where we’re going. To understand the economy’s direction, we need to look at forward-looking indicators like hiring and consumer sentiment.

Small business hiring turns negative

However, while the fundamentals underlying the U.S. economy are strong, the labor market is a clear weak point. After months of cooling job growth, data from Gusto show that small business hiring finally turned negative in October 2025 – the first month of net job losses since January. While the decline was modest (just -5,900 net jobs nationally) and the nation’s unemployment rate remains at a very low 4.3%, it marks a symbolic turning point for the job market.

The October 2025 Gusto Small Business Jobs Report shows that monthly net hiring has been trending downward throughout 2025. From peaks of 94,300 net new jobs in April, hiring has steadily decelerated for companies with less than 50 employees through the year: 86,700 in June, 57,400 in July, 45,900 in August, 19,000 in September, and finally -5,900 in October.

What’s driving this slowdown? Multiple factors are likely at play. For one, rising tariff uncertainty has made many small business owners cautious about expansion – our recent State of Small Business 2025 report found that 4 in 10 U.S. small businesses haven’t hired at all this year. Another factor is that consumer sentiment has weakened, leading some businesses to take a wait-and-see approach on hiring. And finally, continued high interest rates have clearly dampened some companies’ willingness to expand this year.

Importantly, this cooling in hiring is not necessarily a recession signal – it’s more a sign that the labor market is normalizing after the unusual pandemic-era boom. For small business owners, this actually represents an opportunity: the frantic, expensive competition for talent has eased, making it easier to be selective and find the right cultural fits when hiring does resume.

The revenue side

The key to managing any small business is a balancing act between two sides of a financial coin: Driving revenue growth, and keeping expenses under control. Both are partly determined by the sea of economic forces within which companies operate. 

Let’s first look at the revenue side for small businesses, and today’s economic factors impacting it. 

Consumer spending – the now

First let’s look at U.S. consumer spending. This is by far the biggest driver of the economy, making up about 70% of GDP, and is the best overall predictor of what’s possible for revenue growth at most small businesses.

The latest numbers show U.S. consumer spending remaining remarkably healthy, growing at 5.6% annually as of August 2025. This is solid growth by any measure and demonstrates that American consumers are still opening their wallets despite elevated prices and economic uncertainty.

After the dramatic collapse in consumer spending during the early pandemic, spending surged as travel resumed and businesses reopened. In 2025, consumer spending has remained elevated at around 5-6% annual growth rates – healthy by historical standards and supportive of continued revenue growth for most small businesses.

However, the strength in consumer spending creates an interesting puzzle when paired with falling consumer sentiment. Why are consumers still spending if they feel pessimistic about the economy? Part of the answer lies in the job market: most people remain employed, wages are still growing, and accumulated savings from the pandemic era continue to support spending even as confidence wavers.

Consumer sentiment – the future

While consumer spending remains strong today, the future looks more uncertain. Surveys of consumer optimism are a key leading indicator of future spending, and the data here are concerning.

According to the widely-watched University of Michigan Consumer Sentiment Index, consumer confidence fell sharply throughout 2025. After peaking at 74 in December 2024, sentiment dropped to 55.1 by September 2025 – the lowest reading of the year. This 26% decline in just nine months signals growing anxiety among American households about economic conditions ahead.

What’s driving this pessimism? Several factors appear to be weighing on consumers: uncertainty about tariffs and their impact on prices, concerns about job security as hiring slows, and general unease about the direction of the economy. Even as consumers continue spending today, their worsening outlook suggests caution ahead.

For small businesses, this divergence between current spending (which remains strong) and future sentiment (which is clearly weakening) requires careful navigation by small business owners. The revenue environment remains solid for now, but business owners should prepare for potential moderation in coming quarters as weakening confidence eventually translates into more cautious consumer behavior.

What it means for small business 

Given this mixed picture on the revenue side – solid spending today but weakening sentiment for tomorrow – what should small businesses focus on?

• Invest in customer relationships now. With consumers still spending but growing more cautious, this is an ideal time to deepen relationships with your best customers. Focus on exceptional service, loyalty programs, and building the kind of goodwill that keeps customers coming back even when budgets tighten. The businesses that invest in customer satisfaction today will be best positioned when spending inevitably moderates.

• Emphasize value and transparency. As consumers become more discerning with their dollars, clear value propositions matter more than ever. Make sure customers understand what they’re getting for their money, and consider offering flexible pricing or bundling options that make purchase decisions easier during uncertain times.

• Diversify revenue streams where possible. If your business is heavily dependent on discretionary consumer spending, this is a good time to explore products or services that customers view as necessities rather than luxuries. Businesses with more diversified revenue models are better positioned to weather potential upcoming shifts in consumer spending patterns.

The cost side

Next let’s shift to the cost side of the financial equation. What do recent economic indicators tell us about what’s coming for small business costs in late 2025 and early 2026?

Inflation is moderating 

One of the most harmful economic phenomena for small businesses is cost inflation. With razor-thin profit margins and limited cash reserves, small businesses are especially vulnerable to unexpected price increases for business inputs.

The good news? Inflation has come down dramatically from its 2022 peak. At its worst, inflation was surging at 9% per year – a pace not seen since the 1970s “stagflation” era. As of September 2025, inflation has moderated to 3.0% annually, still above the Fed’s 2% target but well within a manageable range for business planning.

This normalization of inflation represents one of the most important economic policy achievements of the past decade. The combination of Fed rate hikes, resolved supply chain disruptions, and moderating commodity prices has brought inflation back under control without triggering a major U.S. recession.

For small businesses, this means the era of shocking monthly price increases is behind us. While some costs continue to rise, they’re doing so at a predictable, more budgetable pace. Businesses can plan with more confidence, knowing that the cost landscape won’t shift dramatically from month to month.

Business loan rates finally declining

For two painful years, small businesses have faced borrowing costs that were prohibitively high for many. The Fed’s aggressive rate hiking campaign sent business loan rates soaring to levels not seen in decades.

But finally, there’s relief on the horizon. As of mid-2025, term loans carry rates of 7.2% to 7.8% for both fixed and variable rates – still elevated by historical standards, but down from the peaks of 8% or higher in 2024. More importantly, the direction is now favorable: with the Fed cutting rates, business borrowing costs should continue to ease in coming quarters.

This shift is crucial for small businesses. High borrowing costs don’t just make expansion expensive – they essentially lock businesses into cash-only operations, preventing growth investments that might otherwise make strategic sense. Our recent State of Small Business report found that 59% of small businesses today are using external financing, highlighting the impact of today’s continued high interest rates on them. As those rates decline, doors will begin to open for businesses that need to finance equipment, inventory, or other growth initiatives.

That said, loan rates in many cases remain roughly double their pre-pandemic levels, meaning the era of ultra-cheap capital is not returning any time soon. Small businesses should still prioritize cash generation over debt financing for the foreseeable future. But the data show that the cost of borrowing is today moving in the right direction for small business owners.

Fed finally begins lowering interest rates

The Federal Reserve’s monetary policy is the hidden force that explains much of the economic story for small businesses over the past three years. When inflation surged in 2022, the Fed moved aggressively, raising rates from near-zero to over 5% in one of the fastest tightening cycles in U.S. history. This bold action worked: It clearly brought surging inflation under control. But the cost of doing so was slowing the U.S. economy by making borrowing much more expensive for businesses of all sizes.

Today, the Fed is pivoting. After holding interest rates steady through most of 2024 and early 2025, the Fed began cutting rates this fall. Two consecutive rate cuts have brought the benchmark effective federal funds rate – a broad measure of Fed interest rate policy – down from 5.33% to 4.09% by October 2025.

This shift in monetary policy is enormously significant for small businesses. Lower Fed rates don’t instantly translate to lower business loan rates, but they do start the process. Over the next 6-12 months, we will see borrowing costs for small business owners continue to ease as the Fed’s cuts work their way through the U.S. banking system.

Importantly, the Fed appears to be committed to this easing path. With inflation moderating and the overall U.S. labor market cooling, Fed policymakers have room to continue cutting rates to support economic growth. For small businesses, this means the cost of capital should become steadily more affordable throughout 2026.

Payroll and benefits costs are normalizing

For most small businesses, payroll costs represent their single largest business expense. After the dramatic wage inflation of 2022-2023, what should small businesses expect for compensation costs ahead?

The latest data show a clear return to normalcy. As of late 2025, total employer costs for wages and benefits are growing at 4.0% annually – in line with overall inflation and well below the 6-7% growth rates of 2022-2023. This represents a huge relief for small business owners who struggled to keep up with escalating labor costs in recent years.

What’s driving this normalization? Several factors are at play. As the labor market has cooled from its pandemic-era frenzy, workers have less leverage to demand large raises. Overall inflation has also moderated, reducing pressure for cost-of-living adjustments. And with more unemployed workers per job opening, employers today are being more selective about total compensation packages.

However, the breakdown of these costs tells an important story for small businesses. Total compensation costs are now $48.05 per hour on average, divided into $33.02 for wages and salaries and $15.03 for benefits. Within benefits, about $3.75 or 7.8% of total compensation is for health insurance costs. And our research shows those costs have risen much faster than inflation in recent years – and are expected to rise next year at the fastest pace in 15 years. During this time, small businesses should work with their advisors to optimize their health insurance offerings to choose a mix of benefits that best fits their budget.

Overall, for small business owners this moderation in total compensation growth represents a return to stability in their largest cost category. After years of uncertainty about wage pressures, more businesses will be able to plan in 2026 with reasonable confidence that their total compensation costs will grow at a more manageable, roughly 4% pace.

Growing slack in the labor market

During the post-pandemic hiring boom of 2021-2022, small businesses faced brutal competition for talent. With far more job openings than available workers, employers were forced into bidding wars that drove up compensation costs and made hiring extremely difficult.

That dynamic today has now reversed. The best measure of overall labor market tightness comes from the BLS JOLTS survey, which tracks U.S. job openings versus unemployed workers. In late 2021 and early 2022, there were roughly 0.5 unemployed workers for every job opening – a historically tight labor market that gave workers enormous leverage.

As of August 2025, the ratio has risen to approximately 1.07 unemployed workers per job opening. This means the labor market has essentially rebalanced: there’s now roughly one available worker for each open position, a much more sustainable hiring environment than the severe talent shortages of 2022-2023.

For small business owners, this rebalancing is welcome news. The desperate scramble to fill positions of recent years has eased. Businesses can now be more selective in hiring, taking time to find candidates who are good cultural fits rather than hiring essentially anyone willing and available to take open jobs. This in turn can lead to better quality hires, lower employee turnover, and ultimately stronger small businesses.

That said, the labor market is still reasonably tight by historical standards. The ratio of 1.07 is far from the 6+ workers per opening seen during recessions. Small businesses still need to offer competitive packages to attract talent, but the pressure has moderated significantly from the extreme levels of recent years.

The tariff wildcard

If there’s one source of genuine uncertainty in the economic outlook, it’s U.S. tariff policy. Throughout 2025, small business owners have experienced a dizzying array of tariff changes, with rates and affected goods shifting rapidly based on evolving trade negotiations. And at the time of this writing, many of the recently imposed tariffs may end up being invalidated altogether by the U.S. Supreme Court, compounding uncertainty for small businesses.

As of November 2025, the average effective U.S. tariff rate stands at approximately 17.9% – the highest level since 1934. This represents a dramatic increase from the 2-3% rates that prevailed before 2025. The path to this level has been volatile, with rates ranging from as low as 2.4% in early January to peaks near 28% in April before settling at current levels.

To economists, tariffs function like an excise tax on business inputs. And like a tax, they represent one-time cost increases for companies rather than ongoing inflation. Businesses heavily exposed to imported inputs have faced significant one-time price shocks, but these won’t compound year after year the way inflation does. However, the sheer unpredictability of U.S. tariff policy today creates planning nightmares for business owners that may be more of an economic problem than the actual tariffs themselves.

Looking ahead, tariff rates appear to have stabilized somewhat in recent months, hovering in the 16-18% range. U.S. trade negotiations continue, and further changes are likely – particularly after the Supreme Court makes a ruling on whether the tariffs enacted via the International Emergency Economic Powers Act (IEEPA) are legal or not. In this environment, the best advice for small businesses is to work with their accountant and advisors to stay informed about how tariffs affect their specific supply chains, and maintain maximum flexibility in sourcing decisions for any business inputs from overseas.

What can small business owners do to help manage tariff uncertainty today? Some strategies include:

• Review your supply chain exposure. Understand which of your inputs are subject to tariffs and explore alternative suppliers from countries with more favorable rates. Diversification reduces risk even if it doesn’t eliminate costs entirely.

• Build flexibility into contracts. With tariff rates continuing to shift, avoid locking into long-term commitments based on current rates. Where possible, include provisions for renegotiation if tariff conditions change materially.

• Maintain cash reserves. Tariff-driven cost increases can happen quickly. Having adequate cash cushions allows you to absorb one-time shocks without disrupting operations or forcing hasty decisions about pricing or suppliers.

• Stay informed but don’t overreact. Tariff policy continues to evolve through negotiations, exemptions, and court decisions. Work with your accountant or advisor to monitor developments that affect your business but avoid making dramatic operational changes based on rates that may shift again soon.

The bottom line: Takeaways for small business owners 

Looking across the broad sweep of U.S. economic indicators for November 2025, several clear themes emerge for small business owners and their advisors:

• The economy is fundamentally sound but in transition. GDP growth at 3.8% and consumer spending at 5.6% demonstrate that America’s overall economic engine is healthy and strong. However, weakening consumer sentiment and cooling hiring signal that businesses and consumers are taking a more cautious stance this fall. This transitional period requires careful navigation – neither panic about any possible recession nor complacency about possible risks ahead.

• Position for improvement as the Fed cuts rates. The Federal Reserve’s pivot toward rate cuts in 2025 is enormously significant for small business owners. Over the next 6-12 months, lower interest rates should translate into easier access to business loans, increased small business investment, and ultimately stronger U.S. economic growth. Small businesses should maintain financial flexibility to take advantage of these improving conditions, whether through planned expansions, equipment investments, or strategic hires in the coming year.

• Plan for 4% compensation cost growth. The dramatic wage pressures of 2022-2023 are likely behind us. Budgeting for roughly 4% annual growth in total compensation costs is a reasonable strategy for 2026 – a manageable, predictable pace that is mostly in line with decreasing overall U.S. inflation. This stability in most small businesses’ largest expense category should makes financial planning significantly easier than it has been in recent years.

• Invest in customer relationships now. With consumer spending still strong but measures of consumer sentiment weakening, this is the ideal moment to deepen customer relationships. Small businesses should focus on exceptional service, transparency in their value proposition to customers, and building loyalty that will persist even if consumer spending slows in coming months. Small businesses that invest in customer satisfaction today will be better positioned to maintain revenue stability tomorrow.

• Take advantage of a rebalancing labor market. The return to roughly one unemployed worker per job opening for the U.S. overall means small business owners can be more selective in hiring compared to in 2022-2023. Focus on finding true cultural fits rather than rushing to fill positions. Better hires today can translate into lower employee turnover and stronger business performance later on. When combined with moderating compensation cost growth, this represents a much healthier hiring environment than the chaotic competition for talent of 2022-2023.

• Maintain flexibility amid tariff uncertainty. With tariff rates stabilized around 18% but subject to change going forward, the key for small businesses is to remain adaptable. Review your supply chain exposure, build flexibility into supplier contracts, and maintain adequate cash reserves to absorb potential shocks. Avoid overreacting to policy changes, but work with your accountant or advisor to stay informed about developments that affect your specific industry.

• Focus on cash flow and financial resilience. In a transitional economy, cash is king. With borrowing costs still elevated (although improving as we enter 2026) and economic uncertainty persisting, small businesses should prioritize strong cash generation over debt-fueled expansion. Businesses with robust balance sheets will be best positioned to weather any unforeseen economic storms ahead, and capitalize on opportunities as U.S. economic conditions improve through 2026 as the Fed lowers interest rates.