Monetary Policy and Asset Prices with Imperfect Credit Markets

prices? As it stands, the theorem provides an important benchmark and enforces careful thinking about financial markets’ workings and the imperfections that would create a world where a firm’s financial position (hence equity prices) affects its ability to engage in production. Many possible imperfections could generate such a world. This article focuses on failures of information. Suppose that only the entrepreneur knows every detail of the proposed project, while outside investors financing the project have no way of knowing exactly what the entrepreneur would do with their funds. Suppose further that outside investors have limited ability to punish an entrepreneur who runs off with their money or squanders it on a misguided production activity. In this scenario, external investors are likely to provide financing only if they know they will be able to Introduction