Firms with private information about the outcomes of production under uncertainty may face capital (liquidity) constraints that prevent them from attaining efficient levels of investment in a world with costly and/or imperfect monitoring. As an alternative, we examine the efficiency of a simple pooling scheme designed to provide a public (cooperative) supply of liquidity that results in the first best outcome for economic growth. We show that if, absent aggregate uncertainty, the elasticity of scale of the production technology is sufficiently small, then efficient levels of investment and growth can always be supported. Finally, some results for a special case (constant elasticity of scale) are examined when investors face aggregate uncertainty. We show that, in addition to a low elasticity of scale for the production function, investors must have sufficiently optimistic prior beliefs if efficient growth is to be achieved regardless of the actual future state of the world.
JEL classification: D30, D50, D82, D92
Key words: private information, production economies, welfare analysis, liquidity
The authors thank Michael Rebello, James Gilkeson, and participants in workshops at the Atlanta Finance Workshop, the Bank of England, and the University of Rome (Tor Vergata). The views expressed here are the authors' and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.
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