Working Paper: NBER ID: w27207
Authors: Vadim Elenev; Tim Landvoigt; Stijn Van Nieuwerburgh
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 policy. The interventions prevent a much deeper crisis by reducing corporate bankruptcies by about half and short-circuiting the doom loop between corporate and financial sector fragility. The additional fiscal cost is zero since program spending replaces what would otherwise have been spent on intermediary bailouts. The model predicts rising interest rates on government debt and slow debt pay-down. We analyze an alternative intervention that targets aid to firms at risk of bankruptcy. While this policy prevents more bankruptcies and has lower fiscal cost, it only enjoys marginally higher welfare. Finally, we study longer-run consequences for firm leverage and intermediary health when pandemics become the new normal.
Keywords: COVID-19; bailouts; corporate credit markets; macroeconomic dynamics; government policy
JEL Codes: E3; E4; E44; E6; G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government interventions (E65) | Reduced corporate bankruptcies (G33) |
| Reduced corporate bankruptcies (G33) | Mitigation of doom loop between corporate defaults and financial sector fragility (G33) |
| Government spending (H59) | Economic stability (E60) |
| Government interventions (E65) | Rising interest rates on government debt (E43) |
| Alternative intervention targeting aid to firms at risk of bankruptcy (G33) | Preventing more bankruptcies (G33) |
| Alternative intervention targeting aid to firms at risk of bankruptcy (G33) | Lower fiscal cost (H69) |
| Acknowledgment of future pandemic risks (H12) | Structural adjustments in the economy (L16) |