Financial Frictions

Question 1

What is h

Answer 1

Effectiveness / efficiency of banks.

H Rt is the cost of default for a borrower.

Higher h makes borrowing more likely to be incentive compatible

Higher h mean lower screening costs?

Question 2

Incentive compatible

Answer 2

Cost of default exceeds revenue from hiding, such that borrower does not default / run away with the money.

Question 3

Credit multiplier and channel by which more efficient banks are good for growth

Answer 3

1 / 1 - h. Bigger credit multiplier increases the amount banks are willing to lend. Means more R&D projects can be financed, R increases, mu increases therefore productivity growth increases

Question 4

Moral hazard

Answer 4

Borrowers think they can borrow the money and run away / default with no consequence.

Higher h increases cost of default

Question 5

Effect of screening costs

Answer 5

Carried by borrower. Increased cost of investing. MC of R&D increases, reducing R and subsequently mu and g

Question 6

Increase in h

Answer 6

More efficient banks. Lower screening costs.

More R&D …

Upper bound of R increases

Question 7

Lenders requirement

Answer 7

They need the equation to be negative in order to lend. Cost of default exceeds revenue from hiding