Can the covid bailouts save the economy?

Abstract

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 this policy response. 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 programme spending replaces what would otherwise have been spent on financial sector bailouts. An alternative intervention that targets aid to firms at risk of bankruptcy prevents more bankruptcies at much lower fiscal cost, but only enjoys marginally higher welfare. Finally, we study longer-run consequences for firm leverage and intermediary health when pandemics become the new normal.

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