Asymmetric Information in the Credit Market and Unemployment Benefit as a Screening Device

An economy where firms-entrepreneurs are different in terms of unobservable projects quality is considered. This paper analyzes a case of adverse selection in the credit market when entrepreneurs have no wealth to offer as a collateral. Both pooling and credit rationing are possible equilibria depending on the proportion of good firms in the borrowers pool. To solve the inefficiencies, different policies are available for the government to implement. If we do not treat the credit market in isolation, it becomes also possible to focus on the labor market. This paper proposes an unemployment benefit to low quality types to encourage them to offer their labor forces rather than asking for a loan.