Interest Rates and Investment Under Competitive Screening and Moral Hazard
37 Pages Posted: 11 Jan 2017 Last revised: 24 Dec 2017
Date Written: December 22, 2017
This paper studies the effect of (market) interest rate changes on investment under competitive screening and moral hazard. Lower (higher) rates ease (hinder) the provision of incentives to entrepreneurs with positive NPV projects to invest in their best project but hinder (ease) banks' efforts to distinguish them from entrepreneurs with negative NPV projects. This might result in a hump-shaped investment curve. Under low rates, screening through limit pricing leaves insufficient profits to low-wealth entrepreneurs to invest in their best project, and consequently, several project qualities might co-exist in equilibrium. Several testable and other implications on the effectiveness of unconventional monetary policy to boost investment are discussed.
Keywords: Interest rates, entrepreneurial wealth, investment, competitive screening, moral hazard
JEL Classification: D82, E30, E44, E58, G01, G21
Suggested Citation: Suggested Citation