The Welfare Implications of Costly Monitoring in Credit Market

Brian Hillier and Timothy Worrall

Economic Journal, 1994, vol. 104, issue 423, 350-62

Abstract: Rationing is a pervasive feature of credit markets. It has been suggested that credit rationing represents a suboptimal allocation of resources. In a general equilibrium model of credit rationing with hidden information and costly monitoring we show that if credit is rationed it is suboptimal but that credit should be rationed more tightly. In equilibrium, loan applicants bear average monitoring costs, whereas for efficiency they should bear marginal monitoring costs which are larger because average monitoring costs increase with quantity as extra loans are accompanied by a rise in the interest rate which increases the number of defaults. Copyright 1994 by Royal Economic Society.

Date: 1994
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