International factor mobility, informal interest rate and capital market imperfection: A general equilibrium analysis

Abstract

This paper makes a pioneering attempt to provide a theory of determination of interest rate in the informal credit market in a small open economy in terms of a threesector general equilibrium model. There are two informal sectors which obtain production loans from a monopolistic moneylender and employ labour from the informal labour market. On the other hand, the formal sector employs labour at an institutionally fixed wage rate and takes loans from the competitive formal credit market. We show that an inflow of foreign capital and/or an emigration of labour raises (lowers) the informal (formal) interest rate while lowers the competitive wage rate in the informal labour market when the informal manufacturing sector is more capital-intensive vis-à-vis the agricultural informal sector. International factor mobility, therefore, increases the degrees of distortions in both the factor markets in this case.

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“…Marjit and Acharyya (2003), Chaudhuri (2003), Mahata, Khan and Nag (2020) etc., have used this simple technique in their works. However, for a rigorous technique of informal interest rate determination starting from the optimizing behavior of the informal sector lender in a general equilibrium setting see Chaudhuri and Gupta (2014) and Chaudhuri (2017). 15 It is easy to check that even if one considers a nonlinear positive relationship between r and r * with a positive intercept term, , like r * = [ + f (r)] with f � (.)…”

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“…These characteristics of the informal credit market have been adequately described and analyzed in Bhaduri (1977), Rudra (1982), Basu (1984Basu ( , 1997, Basu and Bell (1991), Mishra (1994), Chaudhuri (2003) and Chaudhuri and Mukhopadhyay (2009). For a theory of determination of the informal interest rate in a general equilibrium structure, beginning from the microeconomic behaviour of the informal sector lender in an imperfectly competitive credit market, one may go through Chaudhuri and Gupta (2014).…”