A Small Open Economy with Heterogenous Agents Facing Interest Rate Ceilings on Loans

The aim of this paper is to explore the effects of interest rate ceilings in a small open economy. In order to account for many individuals and lending, a model with heterogenous agents is considered. The investigation is focused on two issues: first, how effective are interest rate ceilings at reducing loans and risk in the economy and at what cost; and second, whether imposing interest rate limits produce any different response of the variables to aggregate shocks in the economy. The results obtained from the model show that interest rate ceilings are effective at reducing high risk debt in the financial system. The cost on consumption of reducing this risk is minimum in the model. The findings for the second issue show that interest rate ceilings make debt more responsive to shocks on the interest rates. In particular, the effect in percentage points of an increase of interest rates could be twice as negative on debt under interest rate ceilings.