- P-ISSN 1738-656X
한국개발연구. Vol. 14, No. 1, April 1992, pp. 191-212
https://doi.org/10.23895/kdijep.1992.14.1.191
This paper discusses the role of money in the process of capital accumulation where financial markets are impeded by contract enforcement problems in the context of overlapping generation framework. In particular, in less developed countries (LOCs) creditors may know little about the repayment capability of potential debtors due to incomplete information so that financial instruments other than money may not acceptable to them. In this paper the impediments to the operation of the private financial markets are explicitly modelled. We argue that creditors cannot observe actual investment decisions made by the potential borrowers, and as a result, loan contracts may not be fully enforceable. Therefore, a laissez-faire regime may fail to provide the economy with the appropriate financial instruments. Under these circumstances, we introduce a government operated discount window (OW) that acts as an open market buyer of private debt. This theoretical structure represents the practice of governments of many LOCs to provide loans (typically at subsidized interest rates) to preferred borrowers either directly or indirectly through the commercial banking system. It is shown that the OW can substantially overcome impediments to trade which are caused by the credit market failure. An appropriate supply of the OW loan enables producers to purchase the resources they cannot obtain through direct transactions in the credit market. This result obtains even if the OW is subject to the same enforcement constraint that is responsible for the market failure. Thus, the DW intervention implies higher investment and output. However, the operation of the OW may cause inflation. Furthermore, the provision of cheap loans through the OW results in a worse income distribution. Therefore, there is room-for welfare enhancing schemes that utilize the higher output to develop. We demonstrate that adequate lump sum taxes-cum-transfers along with the operation of the DW can support an allocation that is Pareto superior to the laissez-faire equilibrium allocation.
C50, E51