Working Paper: CEPR ID: DP14701
Authors: Charles M. Kahn; Wolf Wagner
Abstract: We examine how public liquidity should be distributed to firms when immediate production entails externalities, such as by spreading a virus. Direct provision of liquidity can address externalities, but traditional distribution of liquidity (through banks) has informational advantages. We show that which mode is preferred is determined by the variance (but not the level) of firm characteristics in the economy. Traditional provision is always part of the optimal policy when liquidity modes can be combined, and involves promising low interest rates for when the pandemic is over in order to incentivize temporary production shutdowns at firms.
Keywords: Public liquidity; Banks; COVID-19; Mothballing
JEL Codes: G28; G20; G31; I18
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| traditional lending through banks (G21) | welfare of firms (D69) |
| direct lending by public authorities (H81) | welfare of firms (D69) |
| variance of externalities (D62) | mode of liquidity provision (E50) |
| traditional lending can internalize social losses (G21) | welfare outcomes (I38) |
| interest rate commitments (E43) | firm production decisions (D22) |
| optimal liquidity policies (G33) | welfare of firms (D69) |