DP14701 Liquidity provision during a pandemic

Author(s): Charles M. Kahn, Wolf Wagner
Publication Date: May 2020
Keyword(s): banks, Covid-10, mothballing, public liquidity
JEL(s): G20, G28, G31, I18
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14701

We examine how public liquidity should be distributed to firms when immediate production entails externalities, such as by spreading a virus. Direct provision of liquidity can address externalities, but traditional distribution of liquidity (through banks) has informational advantages. We show that which mode is preferred is determined by the variance (but not the level) of firm characteristics in the economy. Traditional provision is always part of the optimal policy when liquidity modes can be combined, and involves promising low interest rates for when the pandemic is over in order to incentivize temporary production shutdowns at firms.