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Microfinance, Subsidies and Dynamic Incentives

Author

Listed:
  • Suman Ghosh

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

  • Eric Van Tassel

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

Abstract

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.

Suggested Citation

  • Suman Ghosh & Eric Van Tassel, 2007. "Microfinance, Subsidies and Dynamic Incentives," Working Papers 07001, Department of Economics, College of Business, Florida Atlantic University.
  • Handle: RePEc:fal:wpaper:07001
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    File URL: http://home.fau.edu/sghosh/web/Ghosh-VanTassel(FinalVersion).pdf
    File Function: First version, 2007
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    Cited by:

    1. Emilios Galariotis & Christophe Villa & Nurmukhammad Yusupov, 2011. "Recent Advances in Lending to the Poor with Asymmetric Information," Journal of Development Studies, Taylor & Francis Journals, vol. 47(9), pages 1371-1390, July.
    2. Drugov, Mikhail & Macchiavello, Rocco, 2008. "Learning and Microlending," CEPR Discussion Papers 7011, C.E.P.R. Discussion Papers.

    More about this item

    Keywords

    microfinance; poverty; moral hazard; contracts;

    JEL classification:

    • O12 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Microeconomic Analyses of Economic Development
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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