DP14714 Can the Covid Bailouts Save the Economy?

Author(s): Vadim Elenev, Tim Landvoigt, Stijn van Nieuwerburgh
Publication Date: May 2020
Keyword(s): bailout, COVID-19, credit crisis, Financial Intermediation
JEL(s): F31, G12, G15
Programme Areas: Financial Economics, Monetary Economics and Fluctuations, Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14714

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 intervention in the corporate debt markets. We find that the policies should be highly effective at preventing a much deeper crisis by reducing corporate bankruptcies by about half, and short-circuiting the doom loop between corporate and financial sector fragility. The fiscal costs are high and will lead to rising interest rates on government debt. We propose a more effective intervention with lower fiscal cost. Finally, we study longer-run consequences for firm leverage and intermediary health when pandemics become the new normal.