Font Size: 

This paper studies the effects of interest rate credit subsidies on economic development in a general equilibrium model with heterogeneous agents, occupational choice and financial frictions. There are two financial frictions: a cost to intermediate loans and a limited liability problem which maps into the degree of enforcement of credit contracts in the economy. Occupational choice and firm size are determined endogenously by an agent's type (ability and net wealth) and the credit market frictions. We then add a credit program in this economy that subsidizes the interest rate on loans. There is a fixed cost (which might be null) to apply for such loans in the form of bureaucracy and regulations.  We show that for the United States, an interest rate credit subsidy does not have a significant effects on output per capita, but it can have important negative effects on wages and government finances.   For Brazil, a developing country in which financial repression is high and the government subsidies heavily loans, our counter-factual exercises show that if the country cuts all interest subsidies, there will no significant quantitative effect on output per capita, wages, inequality  and government finances. However,  when the interest rate subsidy is fixed at the level observed in Brazil, but access to the credit program is increased, then output and wages might both increase, as long as the interest rate subsidy does not not affect directly the spread on non-subsidized loans.

Financial frictions; Subsidized credit; Occupational choice; Development