Liquidity Choice and Misallocation of Credit

December 20, 2019

Preview Citation

Format: Chicago

Ehsan Ebrahimy. Liquidity Choice and Misallocation of Credit, (USA: International Monetary Fund, 2019) accessed November 21, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

This paper studies a novel type of misallocation of credit between investments of varying liquidity. One type of investment is more liquid, i.e., its return is more pledgeable, and the other is more productive. Low liquidities of both investment types imply that the allocation of credit is constrained inefficient and that there is overinvestment in the liquid type. Constrained inefficient equilibria feature non-positive, i.e., one less than or equal the economy’s growth rate, and yet too high interest rate, too much investment and too little consumption. Financial development can reduce long-term welfare and output in a constrained inefficient equilibrium if it raises the liquidity of the liquid type. I show a maximum liquid asset ratio or a simple debt tax can achieve constrained efficiency. Introducing government bonds can make Pareto improvement whenever it does not raise the interest rate.

Subject: Asset and liability management, Credit, Financial institutions, Financial markets, Financial sector development, Labor, Liquidity, Money, Self-employment, Sovereign bonds

Keywords: Aggregate investment portfolio, Credit, Credit market, Financial sector development, Interest rate decrease, Investment demand, Investment project, Investment-tototal investment ratio, Liquid type, Liquidity, Open economy, Pareto efficiency, Self-employment, Sovereign bonds, World interest rate, WP

Publication Details

Pages:

62
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2019/284
Stock No:

WPIEA2019284
ISBN:

9781513521480
ISSN:

1018-5941

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