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Microfinance, Subsidies and Dynamic Incentives

  • Suman Ghosh


    (Department of Economics, College of Business, Florida Atlantic University)

  • Eric Van Tassel


    (Department of Economics, College of Business, Florida Atlantic University)

In this paper we develop a two period model of a credit market to study the interaction between a monopolistic moneylender and a subsidized microfinance institution. We assume that lenders face a moral hazard problem that is diminished as agents are able to take increased equity positions in their production projects. In this setting, we identify a range of subsidy levels for which the behavior of the moneylender complements the poverty reduction mission of the microfinance institution. We also explain why a policy of offering subsidized loans in the second period to agents who are poor due to a project failure in the prior period, does not distort agents’ incentives to work hard and save in the first period. By varying the subsidy level available to the microfinance institution we discover that for small subsidies the moneylender may be better off with the microfinance institution in the market, and that when subsidies are excessive this can harm the poverty reduction mission of the microfinance institution.

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Paper provided by Department of Economics, College of Business, Florida Atlantic University in its series Working Papers with number 07001.

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Length: 30 pages
Date of creation: Nov 2007
Date of revision:
Handle: RePEc:fal:wpaper:07001
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