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Credit Rationing and Government Loan Programs: A Welfare Analysis

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  • Bruce D. Smith
  • Michael J. Stutzer

Abstract

Asymmetric information about borrower default probabilities may lead to inefficient credit rationing of low-risk borrowers in otherwise competitive markets. In a simple model having these properties, we show that some types of government loan programs, such as loan guarantees issued through lenders, might improve economic efficiency. But the incentive for high-risk borrowers to misrepresent their loan quality is worsened by other government loan programs, notably those that try to target aid directly to rationed borrowers. As such, cost-effective programs may increase inefficiency. This surprising result highlights the need to conduct model-specific policy analyses, as opposed to analyses based on model-free performance indicators. Copyright American Real Estate and Urban Economics Association.

Suggested Citation

  • Bruce D. Smith & Michael J. Stutzer, 1989. "Credit Rationing and Government Loan Programs: A Welfare Analysis," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 17(2), pages 177-193.
  • Handle: RePEc:bla:reesec:v:17:y:1989:i:2:p:177-193
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    References listed on IDEAS

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    1. Gale, William G, 1991. "Economic Effects of Federal Credit Programs," American Economic Review, American Economic Association, vol. 81(1), pages 133-152, March.
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    Cited by:

    1. Anginer, Deniz & de la Torre, Augusto & Ize, Alain, 2014. "Risk-bearing by the state: When is it good public policy?," Journal of Financial Stability, Elsevier, vol. 10(C), pages 76-86.
    2. Jeffrey M. Lacker, 1994. "Does adverse selection justify government intervention in loan markets?," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 61-95.
    3. Rajalaxmi Kamath, 2006. "Public inputs and the credit market," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 13(6), pages 733-753, November.
    4. Marco A. Espinosa-Vega & Bruce D. Smith & Chong K. Yip, 1998. "On government credit programs," FRB Atlanta Working Paper 98-2, Federal Reserve Bank of Atlanta.
    5. Hoff, Karla & Lyon, Andrew B., 1995. "Non-leaky buckets: Optimal redistributive taxation and agency costs," Journal of Public Economics, Elsevier, vol. 58(3), pages 365-390, November.
    6. Longhofer, Stanley D., 1997. "Absolute Priority Rule Violations, Credit Rationing, and Efficiency," Journal of Financial Intermediation, Elsevier, vol. 6(3), pages 249-267, July.
    7. Karel Janda, 2005. "The Quantitative and Qualitative Analysis of the Budget Cost of the Czech Supporting and Guarantee Agricultural and Forestry Fund," Working Papers IES 86, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised 2005.
    8. William G. Gale, 1990. "Collateral, Rationing, and Government Intervention in Credit Markets," NBER Chapters,in: Asymmetric Information, Corporate Finance, and Investment, pages 43-62 National Bureau of Economic Research, Inc.
    9. António Antunes & Tiago Cavalcanti & Anne Villamil, 2015. "The effects of credit subsidies on development," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 58(1), pages 1-30, January.
    10. Tuan-Minh Dinh & Edmund Malesky & Trung-Thanh To & Duc-Thanh Nguyen, 2013. "Effect of Interest Rate Subsidies on Firm Performance and Investment Behavior during Economic Recession: Evidence from Vietnam," Asian Economic Journal, East Asian Economic Association, vol. 27(2), pages 185-207, June.
    11. Parker, Simon C, 2002. "Do Banks Ration Credit to New Enterprises? And Should Governments Intervene? President's Lecture Delivered at the Annual General Meeting of the Scottish Economic Society 4-5 September 2001," Scottish Journal of Political Economy, Scottish Economic Society, vol. 49(2), pages 162-195, May.
    12. Uesugi, Iichiro & Sakai, Koji & Yamashiro, Guy M., 2010. "The Effectiveness of Public Credit Guarantees in the Japanese Loan Market," Journal of the Japanese and International Economies, Elsevier, vol. 24(4), pages 457-480, December.
    13. Türkmen Göksel & Barchynai Kimsanova, 2016. "Liquidity Constraints, Interest Rates and Optimal Credit Subsidies," Bogazici Journal, Review of Social, Economic and Administrative Studies, Bogazici University, Department of Economics, vol. 30(2), pages 1-9.
    14. James D. Hamilton, 2013. "Off-Balance-Sheet Federal Liabilities," NBER Working Papers 19253, National Bureau of Economic Research, Inc.
    15. Ma, Chien-Hui & Smith, Bruce D., 1996. "Credit market imperfections and economic development: Theory and evidence," Journal of Development Economics, Elsevier, vol. 48(2), pages 351-387, March.
    16. Soumaré, Issouf & Lai, Van Son, 2016. "An analysis of government loan guarantees and direct investment through public-private partnerships," Economic Modelling, Elsevier, vol. 59(C), pages 508-519.
    17. Iichiro Uesugi & Koji Sakai & Guy M. Yamashiro, 2006. "Effectiveness of Credit Guarantees in the Japanese Loan Market," Discussion papers 06004, Research Institute of Economy, Trade and Industry (RIETI).
    18. Espinosa-Vega, Marco A. & Smith, Bruce D. & Yip, Chong K., 2002. "Monetary Policy and Government Credit Programs," Journal of Financial Intermediation, Elsevier, vol. 11(3), pages 232-268, July.
    19. Boyd, John H. & Smith, Bruce D., 1997. "Capital Market Imperfections, International Credit Markets, and Nonconvergence," Journal of Economic Theory, Elsevier, vol. 73(2), pages 335-364, April.
    20. Li, Wenli, 2002. "Entrepreneurship and government subsidies: A general equilibrium analysis," Journal of Economic Dynamics and Control, Elsevier, vol. 26(11), pages 1815-1844, September.
    21. Deborah Lucas, 2016. "Credit Policy as Fiscal Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 47(1 (Spring), pages 1-57.
    22. Karel Janda, 2011. "Credit Guarantees and Subsidies when Lender has a Market Power," Working Papers IES 2011/18, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised Jun 2011.
    23. Athreya, Kartik B. & Tam, Xuan S. & Young, Eric R., 2014. "Loan Guarantees for Consumer Credit Markets," Economic Quarterly, Federal Reserve Bank of Richmond, issue 4Q, pages 297-352.
    24. Pablo Astorga Junquera, 2017. "Real Wages and Skill Premiums during Economic Development in Latin America," Economics Series Working Papers 153, University of Oxford, Department of Economics.
    25. Stanley D. Longhofer, 1997. "Absolute priority rule violations, credit rationing, and efficiency," Working Paper 9710, Federal Reserve Bank of Cleveland.

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