Credit Rationing and Government Loan Programs: A Welfare Analysis

Abstract

Asymmetric information about borrower default probabilities may lead to inefficient credit rationing of low‐risk borrowers in otherwise competitive markets. In a simple model having these properties, we show that some types of government loan programs, such as loan guarantees issued through lenders, might improve economic efficiency. But the incentive for high‐risk borrowers to misrepresent their loan quality is worsened by other government loan programs, notably those that try to target aid directly to rationed borrowers. As such, cost‐effective programs may increase inefficiency. This surprising result highlights the need to conduct model‐specific policy analyses, as opposed to analyses based on model‐free performance indicators.

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