Asymmetric Information in Credit Markets and Its Implications for Macroeconomics

In this paper we investigate the macroeconomic equilibria of an economy in which credit contracts have both the adverse selection and incentive effects. The terms of credit contracts include both an interest rate and a collateral requirement. We show that in this richer model all types of borrowers may be rationed. Whether or not the economy is in a rationing regime, interest rates charged borrowers may move either pro- or counter-cyclically. If pro-cyclical shocks have a greater effect on the success probabilities of risky techniques than on safe ones, then the interest rate offered depositors may also move counter-cyclically. Increases in the supply of loanable assets can increase or decrease the average interest rate charged borrowers. Finally, we show that the impact of monetary policy on the macroeconomic equilibrium is affected by whether or not the economy is in a regime in which credit is rationed