Falling Interest Rates and Credit Reallocation: Lessons from General Equilibrium

Vladimir Asriyan, Luc Laeven, Martín, Alberto, Alejandro Van der Ghote and Victoria Vanasco
Authors registered in the RePEc Author Service: Alberto Martin

No 16720, CEPR Discussion Papers from Centre for Economic Policy Research

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 is quantitatively significant and - in response to persistent changes in the interest rate - stronger than the traditional balance-sheet channel. We provide evidence of the reallocation effect using US firm-level data.

Keywords: Low interest rates; Financial frictions; Firm heterogeneity; Allocation; Credit; Asset prices; Balance sheet channel; Optimal monetary policy (search for similar items in EconPapers)
JEL-codes: E22 E32 E44 E52 (search for similar items in EconPapers)
Date: 2022-07
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Citations: View citations in EconPapers (1)

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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 (2025)
Working Paper: Falling interest rates and credit reallocation: Lessons from general equilibrium (2022)
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