Credit Subsidies and Economic Growth under Asymmetric Information

The pervasiveness of asymmetric information and its subsequent adverse effects on financial markets and the real economy have been well researched and recognized. However, the study and exploration of using various financial policies by government to mitigate the adverse effects of asymmetric information have not received adequate attention in the existing literature. In reality, governments in most of countries do intervene in credit markets in a number of ways, ranging from interest-rate subsidies (to private enterprises) to loan guarantees and from direct lending of soft loans (low-interest government loans) to liquidity provisions. This observation is particularly poignant as the researchers have just witnessed massive interventions by governments around the world in the credit markets amidst the current financial crisis. Not to mention that credit markets are usually highly regulated. Little work, especially at theoretical level, has been done to understand the effectiveness, and even the desirability, of these credit programs. This project attempts to fill in this gap in the literature by exploring the effects of government credit subsidies, financed by taxes, in a growth context with asymmetric information. The researchers recognize that while the presence of asymmetric information calls for the need of government interventions, say in the form of credit subsidies, one needs to be mindful of the tax implications, and the subsequent market distortions they bring, of those government programs. Thus, the optimal use of varies subsidies will hinge on balancing between the adverse consequences of asymmetric information and the tax-induced distortions. In this context, the researchers will also evaluate and compare the effectiveness of different types of credit subsidies, such as interest-rate subsidies, direct lending, and loan guarantees, in terms of their growth impacts. Among others, this preliminary analysis indicates that the desirability of the credit subsidies seems to depend on the extent of information asymmetry prevailing in the credit market. Finally, data/proxies on government credit subsidies and other loan market variables, as well as macro economic variables, will be collected and brought to bear on these theoretical/analytical model implications.