Asymmetric information and loan contracts in a neoclassical growth model

We consider a neoclassical growth model with risky investment projects in which a borrower's (an investor's) risk type is private information. Our innovation is to determine jointly the equilibrium loan contract and the economy's growth path and the steady-state capital stock. We show that as capital accumulates, credit ationing may fall as an increasing number of lenders choose to acquire costly information to separate borrowers as to type. This transition from credit rationing to screening in rum results in a higher capital accumulation path and higher steady-state capital stock. We also investigate the effects of a decrease in the cost of information on the economy's capital accumulation path and steady-state capital stock. We show that the cost of information must fall below a threshold level before the economy moves from a credit-rationing equilibrium to a screening one. Thus a threshold must be crossed before the steady-state capital stock is increased with a decrease in the cost of information.