Article(electronic)#1August 11, 2017
Structuring Subsidies in a Long-Term Credit Relationship
In: The B.E. journal of economic analysis & policy, Volume 17, Issue 4
ISSN: 1935-1682
Abstract
We study a credit market using an infinite horizon model where an altruistic lender offers loans to agents for production projects that may grow over time. The lender funds the loans using a combination of external debt and subsidies. The optimal way for the lender to subsidize the credit relationships depends on the probability of project growth. When growth is less likely, it is best to commit to ongoing subsidies. However, for a range of growth probabilities, ongoing subsidization may not be credible and this can have negative efficiency implications.