Working Paper: CEPR ID: DP14714
Authors: Stijn van Nieuwerburgh; Tim Landvoigt; Vadim Elenev
Abstract: The covid-19 crisis has led to a sharp deterioration in firm and bank balance sheets. The government has responded with a massive intervention in corporate credit markets. We study equilibrium dynamics of macroeconomic quantities and prices, and how they are affected by government intervention in the corporate debt markets. We find that the policies should be highly effective at preventing a much deeper crisis by reducing corporate bankruptcies by about half, and short-circuiting the doom loop between corporate and financial sector fragility. The fiscal costs are high and will lead to rising interest rates on government debt. We propose a more effective intervention with lower fiscal cost. Finally, we study longer-run consequences for firm leverage and intermediary health when pandemics become the new normal.
Keywords: COVID-19; bailout; credit crisis; financial intermediation
JEL Codes: G12; G15; F31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government intervention in corporate credit markets (H81) | Reduction in corporate bankruptcies (G33) |
| Reduction in corporate bankruptcies (G33) | Prevention of deeper economic crisis (H12) |
| Without government intervention (H19) | Corporate defaults would skyrocket (G33) |
| Corporate defaults would skyrocket (G33) | Severe banking crisis (F65) |
| Government intervention in corporate credit markets (H81) | High fiscal costs of interventions (H59) |
| High fiscal costs of interventions (H59) | Rising interest rates on government debt (E43) |
| Combination of bridge loan programs (H81) | Prevention of bulk of firm bankruptcies (G33) |
| Prevention of bulk of firm bankruptcies (G33) | Mitigation of risk of banking crisis (F65) |
| Long-term consequences of interventions (I12) | Lower corporate leverage (G32) |
| Long-term consequences of interventions (I12) | Healthier financial intermediary sector (G21) |