Informational Easing: Improving Credit Conditions through the Release of Information

o ensure repayment of borrowed funds, lenders require that borrowers undergo costly credit evaluations. In the financial sector, credit often flows along chains of borrowers and lenders who are already familiar with each other’s creditworthiness—a process that minimizes the cost of credit evaluations. However, if the creditworthiness of key participants along a chain is called into question, the chain can break and cut off the flow of credit to final borrowers. If enough chains in the economy break, a financial crisis can ensue, investment by final borrowers can dry up, and output can decline. The flow of credit can stop because a lender believes a borrower has a high default probability or because a lender is uncertain about whether a borrower has a high default probability. The latter may often be the more likely scenario. For example, in a classic bank run, it is unlikely that depositors know the probability that their bank will become insolvent, but it is likely that they worry about the possibility that their bank has high default probability and withdraw their deposits as a precaution. More generally, a decision maker faces risk if the outcomes in his decision problem are random; he faces uncertainty if the outcomes are random and he does not know the probabilities of the outcomes.2 For example, when lenders are uncertain, they cannot assign a single figure to a borrower’s default probability, so they instead assign a range. During economic expansions, this range may be small, such as 1/4 to 1/2 percent; however, during economic downturns, the range may be 2 to 5 percent. If a lender is uncertainty-averse in the sense of Gilboa and Schmeidler (1989), it will charge spreads based on the high end of its range. This decision will be unimportant during expansions, when the range is narrow, but during downturns the required spread may be so high that a borrower cannot afford a loan—and the flow of credit from that borrower to any borrowers farther along the lending chain will be cut off. This paper addresses how central banks can resuscitate lending chains by providing information that reduces