Working Paper: NBER ID: w3024
Authors: William G. Gale
Abstract: This paper analyzes the effects of government intervention in credit markets when lenders use collateral, interest, and the probability of granting a loan as potential screening devices. Equilibria with and without rationing are examined. The principal theme is that credit policies operate through their effect on the incentive compatibility constraint, which inhibits high-risk borrowers from mimicking the behavior of low-risk borrowers. Any policy that loosens (tightens) the constraint raises (reduces) efficiency. Most government credit programs explicitly attempt to fund investors that cannot obtain private financing. In the model presented here, these subsidies increase the extent of rationing and reduce efficiency. In contrast, policies that subsidize the nonrationed borrowers, or all borrowers, are efficiency enhancing, and reduce the extent of rationing.
Keywords: credit markets; government intervention; collateral; rationing; efficiency
JEL Codes: G21; H43
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government interventions in credit markets through subsidies (H81) | Alter the incentive compatibility constraint (D10) |
| Subsidies to low-risk borrowers (H81) | Increase the extent of rationing (D45) |
| Increase the extent of rationing (D45) | Reduce overall efficiency (D61) |
| Subsidies to high-risk borrowers (H81) | Loosen the incentive compatibility constraint (D10) |
| Loosen the incentive compatibility constraint (D10) | Decrease the rationing of low-risk borrowers (G21) |
| Decrease the rationing of low-risk borrowers (G21) | Enhance efficiency (D61) |
| Government interventions in credit markets through subsidies (H81) | Changes in the efficiency of credit allocation (E51) |
| Government interventions in credit markets through subsidies (H81) | Changes in the behavior of lenders (G21) |
| Government interventions in credit markets through subsidies (H81) | Outcomes for different borrower types (G51) |