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The author thanks Elizabeth Asiedu, Edward Frydl, Arend Kouwenaar, Eduardo Ley, and the participants at an African Department seminar for comments on an earlier version. Tom Walter’s editorial suggestions and Rosa Estevez’s secretarial assistance are gratefully acknowledged.
The literature also makes a distinction between equilibrium rationing and dynamic rationing based on whether interest rates are at their long-run equilibrium level or have departed from it. Rationing that exists when interest rates are at their long-run equilibrium level is referred to as equilibrium rationing. When some disturbance in market conditions makes interest rates deviate from their long-run levels, the return to those long-run levels is not instantaneous, because of the “stickiness” emphasized by Keynesian economists. Under the circumstances, the credit rationing that occurs is called dynamic rationing. (Jaffee and Modigliani, 1969). Moreover, a distinction is made between rationing by number of loans and rationing by loan size (Keeton, 1979).
Stiglitz (1993) lists some advantages of low deposit rates of interest. He argues that low deposit rates can be beneficial for an economy whether or not they are passed to firms through low lending rates. Another argument in favor of low deposit rates comes from van Wijnbergen (1983b) and the neostructuralists. They contend that informal credit markets provide more complete intermediation than banks because banks are subject to reserve requirements that reduce credit availability. This assumption supports their argument that, when higher deposit rates induce portfolio shifts from assets in the informal credit markets to bank deposits, the rate of economic growth may be reduced as the overall amount of credit available to businesses contracts. This paper focuses on the formal banking sector.
In developing countries cash in advance is more than an assumption—it is the way transactions are carried out. Hellwig (1993, p. 223) states that “the imposition of the CIA constraint is usually justified on descriptive grounds, by an appeal to realism. The problem with this piecemeal introduction of realism into an otherwise highly idealized model begs the question of what is the function of this constraint, and how does this function fit into the conceptual structure of the overall model.”
Brock and Suarez (2000) suggest that the persistence of high interest rate spreads has been a disturbing outcome of market-oriented reforms in some Latin American countries. In sub-Saharan Africa, during 1996-99, deposit rates averaged 9 percent in Tanzania, 22 percent in Malawi, and 27 percent in Zimbabwe. During the same period, spreads between lending and deposit rates averaged 17 percent, 19 percent, and 14 in Tanzania, Malawi, and Zimbabwe, respectively.
The derived loan offer is nonmonotonic in the lending rate. Although based on risk of default, the model does not exclude asymmetric information.
As in most LDCs, a check is a valid means of payment only when the seller knows and trusts the buyer; otherwise, currency is required.
From a conceptual standpoint, this index is close to the bureaucratic efficiency index (BEI) that can be computed from indices published by Business International.
Other real variables, like, for instance, zt, bt, and kt, are derived in the same manner.
The government provides the representative bank with reserves (in the form of currency), to back the increase in the bank’s deposit liabilities.
Each bank assumes that it is too small for its decisions to affect market interest rates.
The existing informational infrastructure has an impact on the selection of potential borrowers. For instance, when specialized credit reference agencies provide fast and reliable information on the creditworthiness of loan applicants, the lending risk is somewhat reduced. As stated by Mishkin (1992, p. 183), adverse selection takes place before the transaction when bad credit risks are the ones most likely to receive loans. After a loan has been made, good institutions and informational infrastructures help in curbing the cost of contract enforcement and that of monitoring the return of the borrower’s investment project referred to by Williamson (1987).
Bank loans granted in period t and carried into period t + 1.
A caveat to the model is the suggestion that rationing is built into the effective loan amount, limiting the comparative statics analysis to considerations of whether rationing is stiffer or not, depending on the direction the aggregate loan amount takes. The environment in which banks operates in low income developing countries makes it very likely that they almost always ration credit through either the number of loans or their size.
Equation (18), which is key to the analysis carried out subsequently, holds even if b is a choice variable in the household’s decision problem.
Palivos et al. (1993) consider the possibility of reinstatement of the Tobin effect. They suggest that an increase in the inflation (money growth) rate can cause a “sufficient” increase in the fraction of investment purchased on credit that would induce a decrease in the shadow cost of capital. The model presented in this paper does not allow such possibility since higher inflation is unambiguously associated with a reduction in bank credit.
Regulation Q refers to a legislation under which the Federal Reserve System of the United States had the power to set maximum interest rates that banks could pay on savings deposits.
For instance, McKinnon (1989) suggests that raising interest rates above certain limits in “immature” bank-based capital markets can bring about undue adverse selection among borrowers and undue moral hazard in the banks themselves.