Financial Markets and Inflation Under Imperfect Information

IMF Working Papers, June 1, 1994

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Financial Markets and Inflation Under Imperfect Information

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Bibliographic details

• Authors: Jose De Gregorio, Federico Sturzenegger
• Published: June 1, 1994
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781451848359.001

Authors and Publication

• By Jose De Gregorio, Federico Sturzenegger
• June 1, 1994
• IMF Working Papers, Working Paper No. 1994/063
• Issue: 063
• Volume: 1994
• Pages: 34
• DOI: https://doi.org/10.5089/9781451848359.001
• Stock No: WPIEA0631994
• ISBN: 9781451848359
• ISSN: 1018-5941

Research Question and Approach

• Studies the effect of inflation on the operation of financial markets under imperfect information.
• Uses a simple model in which inflation affects firms’ productivity and thereby alters financial intermediaries’ ability to distinguish among heterogeneous firms.

Key Findings

• Inflation reduces the ability of financial intermediaries to distinguish among heterogeneous firms.
• Productivity differentials among firms narrow as inflation increases.
• Narrowing productivity differentials create incentives for risky and less productive firms to mimic high-productivity firms.
• At high rates of inflation, financial intermediaries may be unable to differentiate among customers, potentially leading to pooling equilibria.

Theoretical Mechanism (Model Insights)

• Inflation → firms’ productivity affected → productivity differentials narrow.
• Reduced differential → signaling incentives for low-productivity and risky firms to act like high-productivity firms.
• When signals collapse sufficiently, intermediaries cannot separate types, producing pooling outcomes.

Subjects and Keywords

• Subject: Credit, Inflation, Money, Prices, Production, Productivity, Tax incentives
• Keywords: Credit, firms look, Global, h-firms employment, high-productivity firm, Inflation, low-productivity firm, pooling equilibrium h-firm, Productivity, WP

Practical Implications (Policy-Relevant Points)

• Higher inflation can impair financial intermediation by worsening information problems between lenders and borrowers.
• The model implies that controlling inflation may preserve the informational role of financial intermediaries and reduce adverse selection/moral hazard incentives from lower-productivity or risky firms.

IMF Working Paper: "Financial Markets and Inflation Under Imperfect Information", Jose De Gregorio and Federico Sturzenegger, June 1, 1994.