Costly Monitoring, Loan Contracts and Equilibrium Credit Rationing

This paper develops a model with asymmetrically informed agents and costly monitoring of loan contracts, where an equilibrium can exhibit credit rationing. Borrowers are identical ex ante, but some receive loans and others do not. In contrast to existing credit rationing theories, rationing does not occur here due to inflexible prices, adverse selection or moral hazard. Optimizing behaviour produces a standard debt contract in equilibrium. The aggregate quantity of loans and equilibrium interest rates respond differently depending on whether there is rationing in equilibrium.