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Reflections on credit policy in developing countries: its effect on private investment

  • Dailami, Mansoor
  • Giugale, Marcelo

Previous approaches to credit policy in the stabilization and adjustment of developing countries have emphasized either the role of the availability of credit or the role of its price - that is, the interest rate. The authors argue that effective credit policy in developing countries must take into account both interest rate and credit channels. The authors develop their argument in the context of the link between credit policy and private investment, using a model of firms'investment behavior in an economy with exogenous, time-varying borrowing constraints. The model incorporates a credit ceiling linked to the firms'net worth and the state of the credit market. The state of the credit market depends on factors such as credit and interest rate policy, regulatory and supervisory practices, and market sentiments that banks consider in making lending decisions. These factors affect banks'decisions independent of a borrower's creditworthiness. Thus, in times of tight money, firms that would otherwise have received loans may be denied them and have to postpone or cut back investment plans. The authors use their model to specify an equation relating aggregate private investment to aggregate output and to two credit market variables. Their findings show that interest rates and credit volume exert a joint influence on the behavior of private investment in the countries examined.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 654.

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Date of creation: 30 Apr 1991
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Handle: RePEc:wbk:wbrwps:654
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  1. Dailami, Mansoor, 1990. "Financial policy and corporate investment in imperfect capital markets : the case of Korea," Policy Research Working Paper Series 409, The World Bank.
  2. 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.
  3. Jaffee, Dwight M & Russell, Thomas, 1976. "Imperfect Information, Uncertainty, and Credit Rationing," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 651-66, November.
  4. Calomiris, Charles W & Hubbard, R Glenn, 1990. "Firm Heterogeneity, Internal Finance, and 'Credit Rationing.'," Economic Journal, Royal Economic Society, vol. 100(399), pages 90-104, March.
  5. Mark L. Gertler & R. Glenn Hubbard, 1989. "Taxation, Corporate Capital Structure, and Financial Distress," NBER Working Papers 3202, National Bureau of Economic Research, Inc.
  6. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
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