Credit Market Imperfections Financial Activity and Economic Growth

Abstract

This paper develops a dynamic general-equilibrium model with production to examine the inter-relationships between the real and the financial sectors with and without credit market imperfections. Due to the moral hazard problem, credit rationing may be present, which is associated with a widened financial spread and low effective bank loans, compared to the unconstrained equilibrium. Credit rationing causes both the loan and the deposit rates to rise. In a generalized framework with intergenerational human capital accumulation, credit rationing discourages education investment and reduces output growth. In either unconstrained or constrained equilibrium, the long-run effects of a productivity improvement on real financial activities depends crucially on where it is originated.