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Moral Hazard in Financial Markets: Inefficient Equilibria and Monetary Policies

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  • Alessandro Fedele

    () (Università degli Studi di Milano – Bicocca)

Abstract

This paper presents a moral hazard model of financing in which borrowers adopt two modes of f inance, either issuing bonds or applying for bank loans. The bond rate is set by the borrowers, while the loan rate is chosen by a monopolistic bank. 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. When the informational 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.

Suggested Citation

  • Alessandro Fedele, 2006. "Moral Hazard in Financial Markets: Inefficient Equilibria and Monetary Policies," Rivista di Politica Economica, SIPI Spa, vol. 96(5), pages 111-134, September.
  • Handle: RePEc:rpo:ripoec:v:96:y:2006:i:5:p:111-134
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    References listed on IDEAS

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    1. James, Christopher, 1987. "Some evidence on the uniqueness of bank loans," Journal of Financial Economics, Elsevier, vol. 19(2), pages 217-235, December.
    2. Mark Gertler & Simon Gilchrist, 1994. "Monetary Policy, Business Cycles, and the Behavior of Small Manufacturing Firms," The Quarterly Journal of Economics, Oxford University Press, vol. 109(2), pages 309-340.
    3. Bengt Holmstrom & Jean Tirole, 1997. "Financial Intermediation, Loanable Funds, and The Real Sector," The Quarterly Journal of Economics, Oxford University Press, vol. 112(3), pages 663-691.
    4. Bernanke, Ben S & Blinder, Alan S, 1988. "Credit, Money, and Aggregate Demand," American Economic Review, American Economic Association, vol. 78(2), pages 435-439, May.
    5. Douglas W. Diamond, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Oxford University Press, vol. 51(3), pages 393-414.
    6. Kashyap, Anil K & Stein, Jeremy C & Wilcox, David W, 1993. "Monetary Policy and Credit Conditions: Evidence from the Composition of External Finance," American Economic Review, American Economic Association, vol. 83(1), pages 78-98, March.
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    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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