Working Paper: CEPR ID: DP14838
Authors: Anatoli Segura; Alonso Villacorta
Abstract: We develop a novel framework that features loss amplification through firm-bank linkages. We use it to study optimal intervention in a lockdown that creates cash shortfalls to firms, which must borrow from banks to avoid liquidation. Firms’ increase in debt reduces firms’ output due to moral hazard. Banks need safe collateral to raise funds. Without intervention, aggregate risk constrains bank lending, increasing its cost and amplifying output losses. Optimal government support must provide sufficient aggregate risk insurance, and can be implemented with transfers to firms and fairly-priced guarantees on banks’ debt. Non-priced bank debt guarantees and loan guarantees are suboptimal.
Keywords: COVID-19; Liquidity; Firms; Leverage; Financial Intermediation; Government Interventions
JEL Codes: G01; G20; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Lockdown (K42) | cash shortfalls for firms (G32) |
| cash shortfalls for firms (G32) | firms increase debt to survive (G32) |
| firms increase debt to survive (G32) | increased debt reduces output due to moral hazard (F65) |
| increased debt reduces output due to moral hazard (F65) | banks tighten lending standards due to perceived risks (G21) |
| government interventions with transfers and guarantees (H81) | mitigate initial losses and support bank lending (G21) |
| Lockdown (K42) | firms increase debt to survive (G32) |
| Lockdown (K42) | increased debt reduces output due to moral hazard (F65) |
| Lockdown (K42) | banks tighten lending standards due to perceived risks (G21) |
| Lockdown (K42) | mitigate initial losses and support bank lending (G21) |