Essays on imperfect information and economic growth

Abstract

This dissertation is a collection of essays on economic growth in the presence of asymmetric information between lenders and borrowers in the credit market.

The first chapter considers an endogenous growth model where lenders and capital producing borrowers are asymmetrically informed as to the borrower’s ability to successfully operate an investment project. In contrast to the existing literature, lenders 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 growth rate of the economy and the equilibrium contract’s form are mutually dependent and are determined jointly. It is shown that a decline in the screening cost (representing a more sophisticated financial sector), paradoxically, may lower output growth and that benefit of an advanced financial sector becomes evident only when a threshold level sophistication is crossed.

The second chapter draws a connection between financial development and economic growth in a neoclassical growth model. It is shown that at a low level of capital accumulation, lenders separates the borrowers by denying credit to a fraction of borrowers. As capital accumulates, credit market may function more like a modern credit market with less credit rationing and with an increasing number of lenders purchasing information to separate borrowers. The transition from rationing to screening results in a higher capital accumulation path and a higher steady state capital stock. The present chapter also highlights the conditions under which transition from rationing to screening regime will not occur and the economy may become trapped in a steady state with credit rationing and with a low level of capital.

The third chapter of the dissertation analyzes the effect of inflation rate on the growth rate of output via its effect on the agents’ behavior in the credit market. It is shown that with inflation rate exceeding a critical level, a sharp fall in the growth rate of output takes place as the incentive to purchase information vanishes and borrowers are exclusively separated by means of credit rationing. This chapter also examines the panel data for a large group of countries for the period 1961-88, and shows that the relationship between the inflation rate and the growth rate of output closely follows the prediction of the theoretical model.