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In Defense of Usury Laws

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    Smith was concerned that without controls, funds “…  would be lent to prodigals and projectors, who alone would be willing to give this high interest. Sober people … would not venture into the competition.”Bentham (1790) thought restrictions would stall the engine of economic growth but failed to persuade Smith to change his opinion (e.g., Persky 2007).

  • We thank David Webb and an anonymous referee for very helpful suggestions. Giuseppe Coco gratefully acknowledges financial support from the Italian Ministry for University and Research (MIUR) PRIN project 2007RR7HCN.

Abstract

Usury law is often criticized by economists for curtailing lending and thus creating deadweight costs. This paper shows that if moral hazard leads to credit rationing, a just-binding usury law creates a deadweight gain. This property also holds in most market-clearing equilibria. Independent of social insurance benefits, or curbing present-biased preferences, interest rate caps have merit.

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