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Relationship finance, informed liquidity, and monetary policy

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  • Araujo, Luis
  • Minetti, Raoul
  • Murro, Pierluigi

Abstract

We study the aggregate effects of credit relationships in an economy where lenders provide liquidity and expertise to firms in distress. Lenders' effort in the restructuring of firms' investments endogenously depends on their financial involvement in investments. Firms trade off the benefits of precautionary internal liquidity with the need to incentivize lenders' restructuring effort through their financial involvement. We find that, through these intensive margin effects, credit relationships can induce overinvestment, calling for a positive interest rate policy that departs from the Friedman rule. Credit relationships, however, can enhance the resilience of investment to economic conditions. Unconventional monetary policies that inject liquidity into the lending sector enhance the stabilizing effects of credit relationships but have ambiguous welfare consequences.

Suggested Citation

  • Araujo, Luis & Minetti, Raoul & Murro, Pierluigi, 2021. "Relationship finance, informed liquidity, and monetary policy," Journal of Economic Theory, Elsevier, vol. 193(C).
    • Handle: RePEc:eee:jetheo:v:193:y:2021:i:c:s0022053121000272
    DOI: 10.1016/j.jet.2021.105210
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    More about this item

    Keywords

    Liquidity; Credit relationships; Monetary policy;
    All these keywords.

    JEL classification:

    • D02 - Microeconomics - - General - - - Institutions: Design, Formation, Operations, and Impact
    • E02 - Macroeconomics and Monetary Economics - - General - - - Institutions and the Macroeconomy
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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