Government lending programs in economies with credit market frictions

Costly monitoring may lead to credit rationing in equilibrium in an economy without any adverse selection or moral hazard problems. Given the widespread phenomenon of government intervention in credit markets in developing and developed countries, the natural question then is how effective are these government programs?;In the first chapter, I incorporate government loan programs in a simple closed pure exchange economy with borrowing and lending. Intermediation of funds is facilitated in credits markets characterized by a costly state verification problem. I then show that government loan programs (financed with lump-sum taxes) with co-financing can increase credit rationing when the private agent is the prior claimant in the event of a default. Moreover such programs decrease the expected utility of both borrowers and lenders. On the other hand, when the government is the prior claimant, under some assumptions, such programs decrease credit rationing and increase the expected utility of agents.;Chapter two extends this analysis of government co-financing to an open economy. I conclude that in an open economy co-financing with the government as the prior claimant leads to capital outflows while co-financing with the private lender as the prior claimant causes capital inflows. Chapter three analyzes government interventions in the form of loan guarantees, direct loans, co-financing and interest rate ceilings in a small open economy where both formal and informal credit markets co-exist.;Finally, chapter four revisits the unpleasant monetarist arithmetic in an economy with credit market frictions, and attempts to answer why the unpleasant monetarist arithmetic seems rarely to operate in practice. I show that for low values of the steady state capital stock, the unpleasant monetarist arithmetic may hold even when the rate of return on bonds is less than the growth rate of the economy. More surprisingly, I find that when the steady state values of the capital stock are high enough, increasing bond financing may not necessarily lead to increased rates of inflation even when the conditions set forth by Sargent and Wallace are satisfied.