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Moral hazard in financial markets Inefficient equilibria and monetary policies

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  • FEDELE, Alessandro

Abstract

This paper presents a moral hazard model of financing in which borrowers adopt two modes of finance, either issuing bonds or applying for bank loans. The bond rate is set by the borrowers, while the loan rate is chosen by a monopolisticbank. Bank finance ameliorates the moral hazard problem by monitoring borrowers. Monetary interventions, which affect real economy through the bank lending channel, are justified on the basis of welfare considerations. When theinformational problem is not severe, monitoring is wasteful and welfare is enhanced through a monetary tightening. When the moral hazard problem is severe, monitoring is useful and welfare is increased by a monetary expansion.

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Bibliographic Info

Paper provided by Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) in its series CORE Discussion Papers with number 2005019.

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Date of creation: 00 Feb 2005
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Handle: RePEc:cor:louvco:2005019

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Keywords: moral hazard; monitoring; monetary policies; bank lending channel;

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  1. Ben S. Bernanke & Alan S. Blinder, 1989. "Credit, Money, and Aggregate Demand," NBER Working Papers 2534, National Bureau of Economic Research, Inc.
  2. James, Christopher, 1987. "Some evidence on the uniqueness of bank loans," Journal of Financial Economics, Elsevier, vol. 19(2), pages 217-235, December.
  3. Mark Gertler & Simon Gilchrist, 1993. "Monetary policy, business cycles and the behavior of small manufacturing firms," Finance and Economics Discussion Series 93-4, Board of Governors of the Federal Reserve System (U.S.).
  4. Anil K Kashyap & Jeremy C. Stein & David W. Wilcox, 1992. "Monetary Policy and Credit Conditions: Evidence From the Composition of External Finance," NBER Working Papers 4015, National Bureau of Economic Research, Inc.
  5. Holmström, Bengt & Tirole, Jean, 1994. "Financial Intermediation, Loanable Funds and the Real Sector," IDEI Working Papers 40, Institut d'Économie Industrielle (IDEI), Toulouse.
  6. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
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