- ESSEC Business School
Wednesday, May 17, 2017
Polo Santa Marta, Via Cantarane 24, Room 1.59
In the aftermath of the recent financial crisis, central banks have set their policy rates to unprecedentedly low levels. Yet, the impact of such low rates on investment and growth has been weaker than expected.
I argue in this paper that low rates may in fact harm investment because they exacerbate the adverse selection problem in financial markets. Under low rates, low-quality entrepreneurs search for high-return investment opportunities. To prevent a worsening of the pool of borrowers, financial intermediaries raise their lending standards. Therefore, even high-quality entrepreneurs with insufficient own funds are denied financing and the economy is characterised by low aggregate investment and growth. This phenomenon is perhaps more detrimental in the aftermath of crises, where the average quality of risky projects and the average entrepreneurial wealth have deteriorated.