Conventional economic wisdom says that lowering the price would increase the demand, so when a country is seeking more investment they might try to lower the interest rate on the credits to make people to get more credits to invest more.
However, this doesn´t consider the quality of the investments being made. Having a low "money price" this way can lead to people valuing money less and thus putting less thought on how to use it. This could lead to risky or bad investments that won't improve the economy in the way more investment is expected to. The opposite happens with high interest rate, or at least it seems so from the microcredit experience.
Microcredit are small loans given to low-income people who wouldn't satisfy the requirements of a normal bank to get some credit due to the lack of properties. In order to guarantee that the borrower can be trust they borrow in groups in small communities in such a way that if one in the group doesn´t pay back, all the group is affected (not getting future credit for example). Furthermore they sometimes reduce risk by starting with very small loans and increasing them as the group pays on time. One characteristic is that micro-credit usually have much higher interest compared to other credits, sometimes over 30%. Despite this, the payment rate is very high, reportedly between 95-98%. Microcredit is used to help low-income people to improve their situation by allowing them to start small business. There are critics about this, but the general idea is that low income people need little money to do simple economic activities that can help them get out of poverty. For example, by borrowing $50 a woman could buy chickens and sell the eggs. The chickens reproduce so she can eventually also sell chickens. Even if this is a small business the returns of investment are really high, and it might give enough profit to sustain a family.
So the logic of why microcredit works despite the high interest rate is that people know they have to make a big payment for the money they are getting, so they only get the money if they have a investment opportunity with a good return of investment. If this is true, this would lead to a much smarter use of money and thus an improvement in the overall efficiency of the economy.
So is it better to have a bigger economy or a more efficient economy? Both would be the quick answer, but by increasing the supply of money, its price goes down so there are less incentives to use it in a more efficient way. So perhaps policy that promotes a bigger economy would reduce the efficiency of it.
Bigger or more efficient economy? which one do you think is better or in which conditions one is better than the other one?
Reference and more information about microcredit:
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