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A Theory of Progressive Lending

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  • Dyotona Dasgupta

    (Centre for Development Economics, Delhi School of Economics)

  • Dilip Mookherjee

    (Department of Economics, Boston University)

Abstract

We characterize Pareto efficient long term ‘relational’ lending contracts with one-sided lender commitment, to finance specific investments and smooth intertemporal consumption of a borrower who cannot commit to repaying loans. The borrower can save and accumulate assets, and has strictly concave preferences over consumption. For borrowers with initial wealth above a threshold, the first-best is sustainable with a stationary contract. For poorer agents, there is perpetual but shrinking underinvestment which disappears in the long run. Borrowing, investment and wealth grow and converge to the first-best threshold. Optimal allocations can be implemented by backloaded ‘progressive’ lending: a sequence of one period loans of growing size. Increased borrower bargaining power raises short run consumption and investment, with no long term effects. We discuss extensions to incorporate random productivity shocks.

Suggested Citation

  • Dyotona Dasgupta & Dilip Mookherjee, 2020. "A Theory of Progressive Lending," Working papers 310, Centre for Development Economics, Delhi School of Economics.
    • Handle: RePEc:cde:cdewps:310
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    More about this item

    JEL classification:

    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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