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Low interest rates, capital misallocation and welfare

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  • Dosis, Anastasios

Abstract

This paper studies how the real interest rate affects the (mis)allocation of capital in a small open economy characterized by asymmetric information in the financial market. Low interest rates allow low-productivity firms to enter the pool of borrowers, imposing an information externality that negatively impacts highly productive firms and forces them to reduce their investments. This suggests that, in some cases, although lowering the interest rate can increase total investment and output, it does not necessarily improve welfare. The results align with recent empirical evidence highlighting the adverse effects of low interest rates in southern European countries.

Suggested Citation

  • Dosis, Anastasios, 2025. "Low interest rates, capital misallocation and welfare," Journal of International Economics, Elsevier, vol. 157(C).
    • Handle: RePEc:eee:inecon:v:157:y:2025:i:c:s0022199625000522
    DOI: 10.1016/j.jinteco.2025.104096
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    Keywords

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    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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