Economic Performance, creditor protection and labor inflexibility

We present a static general equilibrium model of an economy with agents with heterogeneous wealth and endogenous credit constraints created by partial loan recovery rates. Higher loan recovery rates and better bankruptcy protection increase output and credit penetration, while the former raises the average interest rate spread and the latter decreases it. We also study the interaction of credit constraint with differences in wealth distribution across countries. In a closed economy, higher loan recovery rates and better bankruptcy legislation raise the prime interest rate, as well as the interest rate spread.