Excess Liquidity, Oligopolistic Loan Markets and Monetary Policy in LDCs

Evidence about commercial banks’ liquidity preference says the following about the loan market in LDCs: (i) the loan interest rate is a minimum mark-up rate; (ii) the loan market is characterized by oligopoly power; and (iii) indirect monetary policy, a cornerstone of financial liberalization, can only be effective at very high interest rates that are likely to be deflationary. The minimum rate is a mark-up over an exogenous foreign interest rate, marginal transaction costs and a risk premium. The paper utilizes and extends the oligopoly model of the banking firm. A calibration exercise tends to replicate the observed stylized facts.