Relationship Finance, Informed Liquidity and Monetary Policy’

Economics

Further details

We study the welfare and output effects of credit relationships in a monetary economy where lenders’ effort in monitoring projects endogenously depends on their financial involvement in projects. Firms trade off the benefits of precautionary internal liquidity with the need to incentivize lenders’ monitoring through their involvement in project financing. We find that tight credit relationships can induce sub optimally high investment levels, calling for an optimal intervention that departs from the Friedman rule. Loose credit relationships, however, amplify the impact of negative real shocks. Credit policies that inject liquidity into the lending sector enhance the welfare effect of credit relationships but have ambiguous effects on stabilization.