Richard Cothren

Equilibrium loan contracts and endogenous growth in the presence of asymmetric information

Abstract This paper considers an endogenous growth model in which an informational asymmetry exists between capital producing borrowers and lenders as to the borrowers ability to successfully operate an investment project. In contrast to previous models of this genre, the lender can induce self-selection either by rationing a fraction of borrowers, or by using a costly screening technology, or by a mix of the two. The equilibrium contracts form and the growth rate of output are mutually dependent and are jointly determined. The effect of the lower cost of screening on the growth rate of output has been considered. We show that a decline in the screening cost, paradoxically, may lower the growth rate of output. Only when a threshold level of sophistication is crossed will the benefit of an advanced financial sector become evident in a higher growth rate.

Asymmetric Information and Loan Contracts in a Neoclassical Growth Model

The authors consider a neoclassical growth model with risky investment projects in which a borrowers (an investors) risk type is private information. Their innovation is to determine jointly the equilibrium loan contract and the economys growth path and the steady state capital stock. The authors show that as capital accumulates, credit rationing may fall as an increasing number of lenders choose to acquire costly information to separate borrowers as to type. This transition from credit rationing to screening in turn results in a higher capital accumulation path and a higher steady state capital stock. They also investigate the effects of a decrease in the cost of information on the economys capital accumulation path and steady state capital stock. The authors show that the cost of information must fall below a threshold level before the economy moves from a credit rationing equilibrium to a screening one. Thus a threshold must be crossed before the steady state capital stock is increased with a decrease in the cost of information. Copyright 1997 by Ohio State University Press.

Asymmetric Information and Optimal Bank Reserves

One traditional argument in favor of bank reserve requirements holds that since a b ank and its depositors are asymmetrically informed as to the banks reserve position and its portfolio, the bank will hold too few reserves and too risky a port folio. This being the case, presumably a central banking authority is equipped t o impose and to monitor a minimal reserve requirement yielding a Pareto superior outcome. This paper analyzes this position in the context of a formalmodel and shows that at least for some parameters of the model there is such a case for a minimal reserve requirement. Copyright 1987 by Ohio State University Press.

A Model of Military Spending and Economic Growth

This paper investigates a model of militaryconflict between two regimes in which eachmay initiate combat in order to confiscateresources from the other. Conflict, or thepotential for same, results in wastefulmilitary spending which lowers growth foreach regime. Equilibrium military spendingis determined in a one-shot game. Analysisof the one-shot game is followed by a studyof the prospects for an equilibrium inwhich regimes lower military spending anddo not engage in combat in repeated play. In this latter case, military spending willbe decreased to a level just sufficient todeter deviations from the no-combatequilibrium. This minimum level increases,and growth decreases, with the internalpolitical instability of each regime. Moreover, an exogenous increase in thedefensive capability of each regime mayeither increase or decrease growth,depending upon the initial level ofmilitary spending and growth.

Asymmetric information, optimal money growth targets, and fed secrecy in a monetary policy game

Abstract This paper analyzes the impact on inflation of requiring the monetary authority to announce money supply targets and punishing it for deviations from same. Two regimes are considered. In one, called the ex ante regime, the target is announced prior to the authoritys obtaining information concerning relevant economic shocks. In the other, called the ex post regime, the announcement is made after the authority obtains relevant information and thus provides the public with data concerning the authoritys private information. It is shown that the ex ante regime may dominate the ex post regime. This follows because an ex post regime may yield a higher mean inflation rate as the monetary authority attempts to exploit the relationship between its announcement and expected inflation.

Long-Run Money Growth and the Liquidity Effect

Limited participation models explain a short-run liquidity effect as arising from the redistribution of income from non-participants in the bond market to participants in the bond market. However, these models also imply that the liquidity effect is smaller the larger is long-run money growth. Using cross-country data, we show that in the short run, the correlation between money growth and the nominal interest rate, and the regression coefficient of the latter regressed on the former are larger (algebraically), the larger is long-run money growth. These results are consistent with this latter implication of the limited participation models.

Trade and Growth in a Model of Allocative Inefficiency

The empirical evidence on the causal relationship between international trade and economic growth is inconclusive. While some studies show that trade leads to growth, others have pointed to a reverse causation. In this paper, we develop a model of international trade and productivity growth in the presence of a misallocation of resources. Misallocation in a country arises as a result of lobbying by firms to establish barriers to the competitive allocation of labor. Misallocation prevents the country from exploiting its technological comparative advantage and leads to a reduction in the volume of trade in the absence of any explicit trade barriers. In the model, whether barriers diminish or worsen with productivity growth depends on the extent of the initial resource misallocation. If the initial resource misallocation is not severe, then productivity growth leads to diminishing barriers and vice versa. In either case, productivity growth strengthens the comparative advantage over time and therefore increases the volume of trade.

Endogenous IPR Protection Expenditure and Economic Growth

This paper analyzes the role of expenditures on property right protection within a standard quality ladder model of endogenous growth. We develop a model where quality of each good improves as a result of innovation. Once the innovator develops a higher quality good there is an exogenously given rate at which the good is targeted for imitation. We allow the innovator to undertake expenditure to protect the good from imitation and thereby reducing the effective probability of imitation. We show that the total intensity of property right protection is inversely related to the cost of property right protection and the effectiveness of the property right system. We also find a subsidy that reduces the per unit cost of property right protection has the same impact as an improvement in the efficiency of the property right system. In both cases the intensity of innovation goes up. We then consider the growth implications of the model and show that in the steady state the economy grows at a constant rate. However, during the transition to the steady state the rate of growth is positively related to the rate of innovation.

Optimal monetary policy in a world with risky investments and financial intermediaries

Abstract This paper investigates investment decisions and monetary policy when financial intermediaries provide a middleman service between borrowers and lenders, and provide an inside money serving as a substitute for outside money. The direction of the Tobin effect is found to depend on the cost of producing inside money. Further, moral hazard problems lead to the possibility of credit rationing in equilibrium. Each of these factors influences optimal monetary policy. Whereas inflation is always optimal in a world with credit rationing, either inflation or deflation is optimal without rationing.

Productivity Growth and Welfare in a Model of Allocative Inefficiency

We develop a model of learning by doing in human capital formation in the presence of allocative inefficiencies. The inefficiencies are a result of lobbying by firms to establish, or prevent, barriers to the perfectly competitive allocation of factors of production (labor). It is shown that lobbying may lead to a static welfare loss depending upon the relative lobbying power of firms seeking to establish barriers to the competitive allocation of labor. We further show that productivity growth via learning by doing may make firms more effective at lobbying by increasing their lobbying power, leading to greater misallocation over time. This magnifies the static welfare loss over time depending on the elasticity of substitution between goods produced in the economy.