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Relationship finance, informed liquidity, and monetary policy

Luis Araujo, Raoul Minetti and Pierluigi Murro ()

Journal of Economic Theory, 2021, vol. 193, issue C

Abstract: We study the aggregate effects of credit relationships in an economy where lenders provide liquidity and expertise to firms in distress. Lenders' effort in the restructuring of firms' investments endogenously depends on their financial involvement in investments. Firms trade off the benefits of precautionary internal liquidity with the need to incentivize lenders' restructuring effort through their financial involvement. We find that, through these intensive margin effects, credit relationships can induce overinvestment, calling for a positive interest rate policy that departs from the Friedman rule. Credit relationships, however, can enhance the resilience of investment to economic conditions. Unconventional monetary policies that inject liquidity into the lending sector enhance the stabilizing effects of credit relationships but have ambiguous welfare consequences.

Keywords: Liquidity; Credit relationships; Monetary policy (search for similar items in EconPapers)
JEL-codes: D02 E02 E44 G21 (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1016/j.jet.2021.105210

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