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Soft budget constraints in a dynamic general equilibrium model


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  • Enrique Gilles



This paper considers an overlapping generations model in which capitalinvestment is financed in a credit market with adverse selection. Lenders´inability to commit ex-ante not to bailout ex-post, together with a wealthyposition of entrepreneurs gives rise to the soft budget constraint syndrome,i.e. the absence of liquidation of poor performing firms on a regular basis.This problem arises endogenously as a result of the interaction betweenthe economic behavior of agents, without relying on political economy ex-planations. We found the problem more binding along the business cycle,providing an explanation to creditors leniency during booms in some Latin-American countries in the late seventies and early nineties.

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Paper provided by UNIVERSIDAD DEL ROSARIO in its series DOCUMENTOS DE TRABAJO with number 006885.

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Length: 35
Date of creation: 28 Feb 2010
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Handle: RePEc:col:000092:006885

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