Does Credit Rationing Imply Insufficient Lending?
David De Meza
London School of Economics & Political Science (LSE) - Interdisciplinary Institute of Management
David C. Webb
London School of Economics
Journal of Public Economics, Vol. 78, Issue 3, November 2000
By combining hidden types and hidden action, this paper shows that the existence of credit rationing need not imply that lending exceeds the full-information level. In this plausible class of models, the appropriate policy is not to subsidise or tax lending but to make alternatives to entrepreneurship more attractive. Doing so may actually increase the number of those borrowing to set up their own business and yield a strict Pareto improvement. The results extend to equilibria characterised by redlining. So, if interest rates fail to clear credit markets, it does not follow that policy should make loans easier to obtain.
Keywords: Credit rationing, overinvestment, lending policy
JEL Classification: D82; D61; H20Accepted Paper Series
Date posted: March 8, 2001
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