Board of Governors of the Federal Reserve System

Abstract:

This paper explores the symbiotic relationship between transformative entrepreneurs and inventors, which is crucial for economic growth. We utilize microdata from Denmark to demonstrate that while the relationship between IQ and general entrepreneurship tends to be negative, it is strongly positive among transformative entrepreneurs. Transformative entrepreneurs, often with higher IQ and education levels, significantly drive R&D and business growth, thereby providing substantial opportunities for inventors. In contrast, average entrepreneurs are more influenced by their family's entrepreneurship background. Our economic model links these dynamics to overall economic progress, highlighting how higher education influences career paths in entrepreneurship and invention. We identify talent misallocation caused by unequal education access, particularly affecting lower-income families. Our findings indicate the most effective policies strengthen the interplay between higher education, innovation, and entrepreneurship to foster transformative businesses and achieve long-run economic growth.

Keywords: Entrepreneurship, R&D Policy, Innovation, IQ, Endogenous Growth.

DOI: https://doi.org/10.17016/IFDP.2025.1410

Abstract:

Long-term debt is the main source of firm-financing in the U.S. We show that accounting for debt maturity is crucial for understanding business cycle dynamics. We develop a macroeconomic model with defaultable long-term debt and equity adjustment costs. With long-term debt, firms have an incentive to increase leverage in order to dilute the value of outstanding debt. When equity issuance is costly, this incentive helps firms raise more debt through a debt dilution channel and mitigates the decline in net worth through a balance sheet channel, dampening the decline in investment in response to a negative financial shock. Using firm-level data, we estimate equity issuance costs and incorporate our findings into an estimated medium-scale DSGE model. Accounting for debt maturity and the cost of equity financing implies that credit supply shocks are the primary drivers of business cycle fluctuations.

Keywords: Long-term debt; Financial frictions; Debt overhang; Macroeconomic activity.

DOI: https://doi.org/10.17016/IFDP.2025.1409

Abstract:

Recent geopolitical tensions have revived interest in understanding the economic consequences of geopolitical fragmentation. Using bilateral trade flows, portfolio investment data, and detailed records of economic policy interventions, we revisit widely-used geopolitical distance metrics, specifically the Ideal Point Distance (IPD) derived from United Nations General Assembly voting. We document substantial variability in measured fragmentation, driven significantly by methodological choices related to sample periods and vote categories, especially in the wake of Russia’s 2022 invasion of Ukraine. Our results show robust evidence of increasing fragmentation in both trade flows and economic policy interventions among geopolitically distant country pairs, with particularly strong effects observed in strategically important sectors and policy motives. In contrast, financial portfolio allocations exhibit weaker, more heterogeneous, and context-sensitive responses. These findings highlight the critical importance of methodological transparency and careful specification when assessing geopolitical realignments and their implications for international economic relations.

Keywords: Fragmentation; Geoeconomics; Trade; Financial Flows

DOI: https://doi.org/10.17016/IFDP.2025.1408

Abstract:

This paper introduces a monthly shortage index spanning 1900 to the present, constructed from 25 million newspaper articles. The index captures shortages across industry, labor, food, and energy, and spikes during economic crises and wars. We validate the index and show that it provides information beyond traditional macroeconomic indicators. Using predictive regressions, we find that shortages are associated with persistently high inflation and lower economic activity. A structural VAR model reveals that, compared to a traditional supply shock, surprise movements in shortages produce less inflation relative to their GDP impact, suggesting that shortages are associated with constraints on price adjustment that limit inflation but magnify the decline in real activity. We also show that post-pandemic shortages and inflation were primarily driven by supply forces, with demand factors playing a less important role.

Keywords: Inflation, Predictive Regressions, Shortages, Structural VAR Model, Textual Analysis

DOI: https://doi.org/10.17016/IFDP.2025.1407

Abstract:

We study optimal credit market policy in a stochastic, quantitative, general equilibrium, infinite-horizon economy with collateral constraints tied to housing prices. Collateral constraints yield a competitive equilibrium that is Pareto inefficient. Taxing housing in good states and subsidizing it in recessions leads to a Pareto-improving allocation for borrowers and savers. Quantitatively, the welfare gains afforded by the optimal tax are significant. The optimal tax reduces the covariance of collateral prices with consumption, and, by doing so, it increases asset prices on average, thus providing welfare gains both in steady state and around it. We also show that the welfare gains stem from mopping up after the crash rather than a pure ex-ante macroprudential aspect, aligning with prior research that emphasizes the importance of ex-post measures compared to preventive policies alone.

Keywords: Collateral Constraints, Credit Market, Financial Crises, Housing and real estate, Macroprudential Policy

DOI: https://doi.org/10.17016/IFDP.2025.1406

Abstract:

Heise et al. (2021) develop a model-based empirical measure—sellers per shipment (SPS)—to characterize how firms organize supply chains in response to a quality control problem. High SPS indicates spot-market purchasing with costly inspections, while low SPS suggests long-term relationships where buyers pay an incentive premium to prevent cheating. Here, we document intuitive variation in US importers' SPS across sectors, and that show shipping characteristics such as average price, quantity shipped and shipment frequency are in each sector consistent with the model of sourcing developed in Heise et al. (2021), providing further confidence in the measure.

Keywords: Supply Chain, Uncertainty, Trade War, Procurement

DOI: https://doi.org/10.17016/IFDP.2025.1405

Abstract:

The incidence of currency counterfeiting and the possible total stock of counterfeits in circulation are popular topics of speculation and discussion in the press and are of substantial practical interest to the Federal Reserve, the U.S. Treasury and the United States Secret Service (USSS), who are jointly responsible for U.S. banknote design, including security features, and production. This paper assembles data from Federal Reserve and USSS sources and presents a range of estimates for the number of counterfeits in circulation in the United States. In addition, the paper presents figures on counterfeit passing activity by denomination, location, and counterfeit type.

The paper has two main conclusions: first, the stock of counterfeits in the United States as a whole is at most about $30 million, or about 1 in 40,000 notes and is likely about $15 million, or on the order of 1 every 80,000 genuine notes in both piece and value terms. This estimate marks a significant decline from the estimate of 1 in 10,000 notes presented in Treasury (2006) using similar methods and data sources, and the decline is likely at least partially due to increased circulation of higher-security banknotes as well as increased public education about U.S. dollar banknote security features. Second, when counterfeit notes of reasonable quality are considered, losses to the U.S. public from only the high-quality counterfeits of the most commonly used notes, the $20 and smaller denominations, are minuscule. However, there is a range of estimates overall for counterfeits in circulation, and these estimates vary by denomination.

Keywords: Banknotes, counterfeiting, estimation, money

DOI: https://doi.org/10.17016/IFDP.2025.1404

Abstract:

We use bilateral cross-border bank claims by nationality to assess the effects of geopolitics on cross-border bank flows. We show that a rise in geopolitical tensions between countries — disagreements in UN voting, broad sanctions, or sentiments captured by geopolitical risk indices — significantly dampens cross-border bank lending. Elevated geopolitical tensions also amplify the international transmission of monetary policies of major central banks, especially when geopolitical tensions coincide with monetary policy tightening. Overall, our results suggest that geopolitics is roughly as important as monetary policy in driving cross-border lending.

Keywords: Monetary policy; Geopolitical tensions; Cross-border claims; Diff-in-diff estimations

DOI: https://doi.org/10.17016/IFDP.2025.1403