IDEAS home Printed from
   My bibliography  Save this paper

Macroeconomic instability of the less developed country economy when bank credit is rationed


  • David F. Spigelman


During the early 1980s, many less developed countries (LDCs) experienced a phenomenon which is not readily explicable using conventional macroeconomic theory: accelerating inflation coupled with output contraction. Moreover, arguments based on supply shocks do not adequately explain the performance of the LOCs over this period. In explaining the apparent anomaly of accelerating inflation coupled with output contraction, the model developed here assigns an important role to the availability of bank credit. ; In many LDCs, the government fixes interest rates on bank deposits and loans. If rates on loanable funds are set below market clearing levels, this leads to credit rationing. Generally, firms must pay wages to workers in advance of the receipts from sales. Bank credit is needed to finance the hiring of labor when there are few alternative sources of finance. Loan availability can thus have a crucial impact on the supply of output. The credit constraint is exacerbated when the government's fiscal deficit instigates inflationary pressure. In response, households reduce deposit holdings leading to a contraction in loan availability and recession. ; Initially, the fiscal deficit and the money supply are assumed to be exogenously determined. Later, the analysis examines a feedback effect of inflation leading to increases in the fiscal deficit and further inflationary pressure. As inflation accelerates, individuals try to shift out of money balances and into inflation hedges contracting the real money supply, real loan availability, and output. Thus the model suggests an explanation for the vicious circle of accelerating inflation and declining output which is observed in many LDCs.

Suggested Citation

  • David F. Spigelman, 1987. "Macroeconomic instability of the less developed country economy when bank credit is rationed," International Finance Discussion Papers 305, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgif:305

    Download full text from publisher

    File URL:
    Download Restriction: no

    File URL:
    Download Restriction: no

    References listed on IDEAS

    1. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
    Full references (including those not matched with items on IDEAS)

    More about this item


    Developing countries ; Loans; Foreign;


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:fip:fedgif:305. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Franz Osorio). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.