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This paper evaluates the impact on consumer welfare of the constraints on increasing interest rates present in the Credit Card Act. We develop a model of consumer financing in a setting where information asymmetry between a consumer and a lender arises over time and triggers adverse selection. We find the competitive equilibrium of this setting and show that restrictions on increasing the interest rate, as in the Credit Card Act, are welfare decreasing for a large set of parameters. The Card's restrictions lead to higher credit card interest rates for low credit-quality consumers and lower credit limit for high credit-quality consumers; these negative effects on welfare are only partially offset by lower up-front fees. We find similar results when we extend our analysis to settings in which consumers have limited rationality.
How does financial development affect the magnitude of the business cycles fluctuations? We examine this question in a general equilibrium model with heterogeneous agents and endogenous credit constraints based on Kiyotaki (1998). We show that there is a hump-shaped relationship between the degree of financial frictions and the amplification of unexpected productivity shocks. This non-monotonic relation is due to the fall in financial frictions having two opposite effects on the response of output. One effect is the reallocation of productive inputs between agent types, which, while active, increases with the fall in financial frictions. The other effect is the change in the demand of inputs, which decreases with the fall in financial frictions. At low levels of financial development the reallocation effect dominates and a fall in financial frictions increases the amplification of productivity shocks. In contrast, at higher levels of financial development, a fall in financial frictions decreases the shock amplification because the reallocation effect disappears while the effect on the demand of inputs is still present.
This paper analyzes the effects of incentive-pay and accounting discretion on earnings management. I develop a dynamic model of earnings reporting in which the cost of earnings management is endogenous, and in which a privately informed manager trades-off incentives to manipulate earnings which increases the firm's stock-price and his current period payoff against incentives to be honest which improves his reputation and future payoff. I find that more incentive-pay and more accounting discretion can lead to less earnings management. Incentive-pay and accounting discretion make a manager's per-period payoff more sensitive to reports. This effect increases both the manager's current period payoff to manipulating earnings, and the manager's payoff to having a better reputation. When having a better reputation dominates the benefit of increasing the current period payoff, the manager does less earnings management.
Information and Business Cycles, with Haresh Sapra