Loan Guarantees in a Democracy

32 Pages Posted: 4 Apr 2022 Last revised: 1 Feb 2024

Date Written: June 01, 2024

Abstract

We study the political economy of loan guarantees within a credit-rationing framework. In this framework, a government uses guarantees to decrease the borrowing cost, thus making more households incentive compatible. This shifts capital to productive projects (allocative effect). Backed by taxpayers, loan guarantees also shift consumption from non-borrowers to borrowers (redistributive effect). While a welfare-maximizing planner is only concerned about the allocative effect, voteshare-maximizing politicians' decision is driven by both effects. We show that even when the majority is formed by borrowers, who are the beneficiaries of the redistributive effect, the allocative effect reins in the generosity of guarantees.

Keywords: loan guarantees, redistributive effect, allocative effect, voting JEL Classification: D72, G28

JEL Classification: D72, G18

Suggested Citation

Papageorgiou, Stylianos and Ziros, Nicholas, Loan Guarantees in a Democracy (June 01, 2024). Available at SSRN: https://ssrn.com/abstract=4053339 or http://dx.doi.org/10.2139/ssrn.4053339

Stylianos Papageorgiou (Contact Author)

University of Cyprus ( email )

Cyprus

Nicholas Ziros

University of Cyprus

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