Money, Banking, and Financial Markets

Understand the principles, understand the future

For at least the past 30 years, the rate of U.S. business formation has been falling and the average age of existing firms has been rising. Since 2000, two other things have happened: productivity growth has slowed, while many skilled jobs have disappeared. Startups are thought be a key source of innovation in the economy and of net job creation. At the same time, as Schumpeter’s notion of creative destruction suggests, the death of old firms is a critical part of the renewal process. So, the declining trend of entry and exit has people worried that U.S. business dynamism is ebbing (see our earlier post).

How concerned should we be? To be completely honest, we don’t really know; at least, not yet. But the answer is important, because it can help orient the U.S. economic policy framework to support the creation of successful businesses that generate high-quality jobs. In this post, we summarize some new research aimed at helping us understand what the decline in business formation really means. Does it signal a fall in the number of successful firms that contribute substantially to business value added, productivity, and employment? Or, is it a decline in the formation of firms that never exceed a tiny scale and have little impact on the broader economy?

Prior to the financial crisis of 2007-2009, many people took market liquidity for granted. So, when the ability to convert assets into cash eroded, the issue became one of survival for some intermediaries. Today, both investors and regulators are focusing on “the ability to rapidly execute sizable securities transactions at a low cost and with a limited price impact” (see Fischer). And there has been an intense debate about whether post-crisis regulations themselves have diminished the supply of liquidity (see our earlier post)...

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... the site where you can learn about finance and economics. We provide commentary on events in the news and on questions of more lasting interest. Because the financial system is constantly evolving, our analysis is informed by a set of core principles: understand the principles, understand the future. The opening excerpts of our two most recent posts appear above. For prior posts, click on the Commentary link to the left, or on the month-by-month Archives to the right. Alternatively, if you are interested in a specific topic, use the tags.

The site also provides material related to our textbook, Money, Banking and Financial Markets, 5th edition, 2017. The Five Core Principles on which the book is based are highlighted here. In addition, Cecchetti and Schoenholtz 5e systematically integrates the use of economic and financial data from FRED, the online database provided by the Federal Reserve Bank of St. Louis. Click on FRED Lessons on the left to access help on how to use this incredible resource.

Steve Cecchetti and Kim Schoenholtz

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