Adverse Selection in the Overlapping Generations Model: The Case of Pure Exchange

Abstract

We examine the general equilibrium consequences of credit rationing that results from an adverse selection problem. Relative to a full information benchmark economy, static incentive problems result in reductions in the rate-of-return at inside money equilibria, and hence can cause dynamic inefficiency. These problems also create a role for outside money; and may convert otherwise "classical" into "Samuelsonian" economies. However, even the presence of money does not support steady state equilibria with constrained optimality properties. Policies that do support constrained optima are outlined, as are the consequences of credit rationing for the financing of government deficits. Journal of Economic Literature Classification Numbers: E13, E40, E44, E50, G14.