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Reflections on credit policy in developing countries : its effect on private investment, Volume 1
Author:Dailami, Mansoor; Giugale, Marcelo; Date Stored:1991/04/01
Document Date:1991/04/30Document Type:Policy Research Working Paper
SubTopics:Environmental Economics & Policies; International Terrorism & Counterterrorism; Economic Theory & Research; Banks & Banking Reform; Financial IntermediationLanguage:English
Major Sector:FinanceReport Number:WPS654
Sub Sectors:Financial Sector DevelopmentCollection Title:Policy, Research, and External Affairs working papers ; no. WPS 654. Financial policy and systems
Volume No:1  

Summary: Previous approaches to credit policy in the stabilization and adjustment of developing countries have emphasized either the role of the availability of credit or the role of its price - that is, the interest rate. The authors argue that effective credit policy in developing countries must take into account both interest rate and credit channels. The authors develop their argument in the context of the link between credit policy and private investment, using a model of firms' investment behavior in an economy with exogenous, time-varying borrowing constraints. The model incorporates a credit ceiling linked to the firms' net worth and the state of the credit market. The state of the credit market depends on factors such as credit and interest rate policy, regulatory and supervisory practices, and market sentiments that banks consider in making lending decisions. These factors affect banks' decisions independent of a borrower's creditworthiness. Thus, in times of tight money, firms that would otherwise have received loans may be denied them and have to postpone or cut back investment plans. The authors use their model to specify an equation relating aggregate private investment to aggregate output and to two credit market variables. Their findings show that interest rates and credit volume exert a joint influence on the behavior of private investment in the countries examined.

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