Socially Excessive Bankruptcy Costs and the Benefits of Interest Rate Ceilings on Loans

Marco A. Espinosa-Vega and Bruce D. Smith
Working Paper 2001-27
November 2001

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The authors study the capital accumulation and welfare implications of ceilings on loan interest rates in a dynamic general equilibrium model. Binding ceilings on loan rates reduce the probability of bankruptcy. Lower bankruptcy rates result in lower bankruptcy and liquidation costs. The authors state conditions under which the resources freed by this cost-saving result increase the steady state capital stock, reduce steady state credit rationing, and raise the steady state welfare of all agents. The authors also argue that the conditions stated are likely to be satisfied in practice. Finally, their results hold even if initially there is capital over-accumulation.

JEL classification: E44, E58, G28

Key words: interest rate ceilings

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.

Please address questions regarding content to Marco A. Espinosa-Vega, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street, N.E., Atlanta, Georgia 30309-4470, 404-498-8630, 404-498-8956 (fax),, or Bruce D. Smith, Economics Department, University of Texas at Austin, Austin, Texas 78712, 512-475-8548, 512-471-3510 (fax),