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Natural Rates of Interest Could Be Affecting U.S. Business Dynamism: Fed’s Harker

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Contact: Daneil Mazone, E-mail Media Relations, 215-574-7163

Philadelphia — A central characteristic of the U.S. economy — business dynamism — has been in steady decline for several decades, and new research from the Federal Reserve Bank of Philadelphia may help explain why. Philadelphia Fed President and CEO Patrick Harker discussed the work in a speech to business economists.

Dynamism — the natural turnover of businesses and workers entering and exiting the market and labor force, or moving between jobs — has historically been elevated in the U.S. However, “Over the past three decades or so, dynamism has been in decline. In particular, the data show lower business start-up activity, slowing labor reallocation, and much less worker mobility,” a trend Harker noted that runs counter to popular conceptions of the American economy.

A possible contributing factor, according to Philadelphia Fed research, is the sustained global decline in interest rates that started in the late 1990s. Harker noted that this is not the rate set by the Federal Reserve, which is called the federal funds rate, but natural rates of interest, “an independent function of economic forces that are beyond the control of us mere mortals on the FOMC.”

In an environment of low natural rates, larger, older, better-leveraged firms have a borrowing advantage. That same advantage may make them more likely to buy up new ideas as they enter the market. “More research is needed, and there is no direct evidence that decreased interest rates have induced larger businesses to borrow with the specific intent of accumulating ideas. However, there is certainly a logical connection. If lower borrowing costs are causing more new ideas to be immediately absorbed into larger firms, then a drop in the start-up rate and growing concentration of sales in large firms are natural consequences.”

Dynamism is an important factor in economic growth, though “I should note here that dynamism, much like food or wine, should be taken in moderation, and an excess could lead to something of an economic hangover. …” However, “in an environment with the right amount, it has its intended effect: Resources are channeled to more productive uses, workers are more engaged with the labor market, and innovation is nurtured.”

Read the speech.

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