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Keynes Fund

 

Summary of Project Results


Applied theory project:

This project studied related but different questions: Given the institutional framework of a particular economy and the level of credit market imperfections is it cost-effective for the government to subsidize credit? Preferential interest rate policies are often used to remedy the problem of credit market frictions. This paper constructs a general equilibrium model with heterogeneous agents, imperfect enforcement and costly intermediation to assess the effects of different credit policies on inequality and development. Occupational choice and firm size are determined endogenously by an agent’s type (ability and net wealth) and credit market frictions. The credit program subsidizes the interest rate on loans. We find that the credit subsidy policy has no significant effect on output, but it may have negative effects on wages. Therefore, our results suggest that providing interest rate subsidies is not an effective way to reduce the underinvestment problem that can result from capital market frictions. Countries should focus on financial reforms that improve the functioning of financial and credit markets directly, such as reforms that increase creditor protection, and decrease asymmetric information and intermediation costs. In developing countries with a high level of financial repression, such reforms might have a sizeable impact on development, while, in general, credit subsidies function as a transfer from workers to a small group of entrepreneurs. Such programs seem better explained by political, rather than economic considerations.

 

Empirical project:

Besides these simulation exercises in which we constructed an artificial economy and simulated different credit policies, we also investigated the causal effect of better credit conditions on investment and productivity of Brazilian manufacturing firms. The case of Brazil is very interesting. The ratio of subsidized loans provided by its National Development Bank (BNDES) on total credit is large, about 27 of all productive credit - accounting for about 7 percent of total national income. In addition, Brazil is well known to have a repressed financial market with one of the largest interest rate spreads in the world. We explore a variation in access to a targeted loan program from the Brazilian Development Bank (BNDES) to assess the causal effect of better credit conditions on investment and productivity of Brazilian manufacturing firms. We used firm level data obtained from a confidential survey constructed by the Brazilian Institute of Statistics (IBGE), called the Annual Industrial Survey (PIA), which monitors the performance of Brazilian firms in the extractive and manufacturing sectors. They are yearly survey from 1996 to 2010 from all firms with 30 or more employees. The estimated causal effects point to positive shifts in the trend for investment rates and productivity indexes; however, after considering firm and year fixed effects, such effects remain statistically significant only for the permanent changes on credit conditions. Our empirical strategy resembles that of Banerjee and Duflo (2014, Review of Economic Studies) in evaluating whether or not firms are credit constrained in India. Therefore, the empirical evidence gives support to the dynamics of firms generated in our theoretical framework and shows that at least at the firm level credit subsidies can increase investment and productivity of financially constrained firms.

 

Research Output


The Effects of Credit Subsidies on Development, António Antunes, Tiago Cavalcanti and Anne Villamil, Economic Theory, (2015) Vol 58(1), pp 1-30. (Lead article)

Abstract: Under credit market imperfections, the marginal product of capital may not be equalized, resulting in misallocation and lower output. Preferential interest rate policies are often used to remedy the problem. This paper constructs a general equilibrium model with heterogeneous agents, imperfect enforcement and costly intermediation. Occupational choice and firm size are determined endogenously by an agent’s type (ability and net wealth) and credit market frictions. The credit program subsidizes the interest rate on loans and requires a fixed application cost, which might be null. We find that the credit subsidy policy has no significant effect on output, but it may have negative effects on wages. The program is largely a transfer from households to a small group of entrepreneurs with minor aggregate effects. We also provide estimates of the effects of reducing the frictions directly. When comparing differences in US output per capita in a baseline case to simulations with counterfactually high frictions, intermediation costs and enforcement explain about 20–25 % of the output gap. We include a transition analysis. Copyright Springer-Verlag Berlin Heidelberg 2015.

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Access to long-term credit and productivity of small and medium firms: A causal evidence, Tiago Cavalcanti and Paulo Vaz, Economics Letters, (2017) Vol 150, pp  21-25.

Abstract: This letter assesses the impact of a variation in access to a targeted loan program from Brazil’s development bank on investment and productivity. Results suggest that eligible firms increased their relative investment rate and productivity, but results are robust only for permanent rather than temporary improvements in access to credit.

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Dr. Tiago Cavalcanti

 

Dr Tiago Cavalcanti is University Reader in Economics at the University of Cambridge, Fellow of Trinity College, Adjunct Professor at Sao Paulo School of Economics-FGV. His research expertise is Macroeconomics, Growth, Economic Development.

 

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