By combining hidden types and hidden action, this paper shows that the existence of credit rationing need not imply that lending exceeds the full-information level. In this plausible class of models, the appropriate policy is not to subsidise or tax lending but to make alternatives to...

This paper examines banks' provision of liquidity to depositors and provision of loans. The problem identified is that banks may not be able to provide new funds for borrowers who are short of cash, because either the return on investments is poor, or because depositors withdraw more funds than...

This paper develops a simple model of bank lending and liquidity shortages. Firms borrow from banks in the form of long term renegotiable bank loans. Banks themselves are financed through uninsured non-renegotiable deposit contracts. Bank liquidity plays a crucial role in the intermediation...

Compensation schemes often reward success but do not penalize failure. Fixed salaries with stock options or bonuses have this feature. Yet the standard principal-agent model implies that pay is normally monotonically increasing in performance. This paper shows that, under loss aversion, there...

Equilibrium credit rationing, in the sense of Stiglitz and Weiss, is shown to imply that the marginal cost of funds to the borrower is infinite. So entrepreneurs have an overwhelming incentive to cut their loans by a dollar and so avoid rationing. Ways of doing this include scaling down the...

Empirical evidence suggests that capital-market constraints prevent low-wealth individuals from setting up in business. This paper shows this finding to be consistent with socially excessive lending and an interest-rate tax being welfare-improving. One feature of the model, banks' inability to...

This paper investigates the implications of adverse selection for capital market equilibrium when borrowers are risk averse. K. J. Arrow and R. C. Lind (1970) argue that when capital markets fail to spread risk properly interest rates are too high. The market adds a risk premium that the social...