Working Paper: CEPR ID: DP16658
Authors: Viral Acharya; Simone Lenzu; Olivier Wang
Abstract: We build a model with heterogeneous firms and banks to analyze how policy can affectthe efficiency of credit allocation and long-term economic outcomes. When transitorydemand or productivity shocks are small, conventional monetary policy can restoreefficient bank lending and production by lowering interest rates. For moderately largeshocks, however, conventional policy may hit the effective lower bound, necessitatingunconventional policy such as regulatory forbearance towards banks to stabilize theeconomy. Aggressive unconventional policy runs the risk of introducing zombie lending and a “diabolical sorting”, whereby low-capitalization banks extend new credit orevergreen existing loans to low-productivity firms. In a dynamic setting, policy aimedat avoiding short-term recessions can be trapped into protracted excessive forbearance due to congestion externalities imposed by zombie lending on healthier firms.The resulting economic sclerosis transforms transitory shocks into phases of delayedrecovery and potentially permanent output losses. Our model highlights the importance of maintaining a well-capitalized banking system to avoid such policy traps asnot raising capital requirements upfront but raising them significantly upon the arrivalof shocks can also backfire by encouraging zombie lending.
Keywords: bank capital; credit misallocation; evergreening; forbearance; conventional and unconventional monetary policy
JEL Codes: E44; E52; G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Conventional monetary policy (E52) | Efficient bank lending (G21) |
| Conventional monetary policy (E52) | Economic production (E23) |
| Conventional monetary policy (when shocks are moderately large) (E63) | Unconventional measures (regulatory forbearance) (E52) |
| Unconventional measures (regulatory forbearance) (E52) | Zombie lending (G21) |
| Zombie lending (G21) | Misallocation of resources (D61) |
| Misallocation of resources (D61) | Adverse productivity spillovers on healthy firms (D62) |
| Zombie lending (G21) | Economic sclerosis (E66) |
| Economic sclerosis (E66) | Delayed recovery (C41) |
| Economic sclerosis (E66) | Permanent output losses (F69) |
| Regulatory forbearance (G28) | Credit allocation (E51) |