Falling interest rates and credit reallocation: lessons from general equilibrium

Vladimir Asriyan, Luc Laeven, Alberto Martin, Alejandro Van der Ghote and Victoria Vanasco

No 3070, Working Paper Series from European Central Bank

Abstract: We show that in a canonical model with heterogeneous entrepreneurs, financial frictions, and an imperfectly elastic supply of capital, a fall in the interest rate has an ambiguous effect on aggregate economic activity. In partial equilibrium, a lower interest rate raises aggregate investment both by relaxing financial constraints and by prompting relatively less productive entrepreneurs to invest. In general equilibrium, however, this higher demand for capital raises its price and crowds out investment by more productive entrepreneurs. When this reallocation is strong enough, a fall in the interest rate reduces aggregate output. A numerical exploration of the model suggests that this reallocation effect i s quantitatively significant an d – in response to persistent changes in th e interest rate – stronger than the traditional balance-sheet channel. We provide evidence of the reallocation effect using US firm-level data. JEL Classification: E22, E23, E32, E44, E52

Keywords: economic activity; general equilibrium; interest rates; reallocation (search for similar items in EconPapers)
Date: 2025-07
Note: 261593
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Related works:
Journal Article: Falling Interest Rates and Credit Reallocation: Lessons from General Equilibrium (2025)
Working Paper: Falling Interest Rates and Credit Reallocation: Lessons from General Equilibrium (2022)
Working Paper: Falling interest rates and credit reallocation: Lessons from general equilibrium (2022)
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20253070

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